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Being competitive in today’s business environment requires investments in software, services and software-as-a-service (Saas). Information technology financing allows businesses to reduce upfront cash outflow and then redirect those savings to other expenses.
Ways to finance IT expenditures and IT businesses include factoring, supply-chain financing, loans and venture capital funding. This article will focus on information technology factoring – which is a sale of pending invoices to a third-party financing company or a bank – and loans.
The advantage of factoring is that it is suitable for startups as long as their clients are creditworthy—and does not require any assets, making it a good option for businesses that have already pledged their assets to a lender. It is a good way to obtain working capital to fund expenses, such as payroll for engineers, developers and other high-income earners that your business employs.
Business Factors works directly with many types of IT businesses, including high-tech manufacturing, technical consulting, IT staffing, engineering consulting, and customer-support services. To find the best working capital solution for your business, please contact one of our executives.
Options to finance an IT business include factoring – the sale of pending invoices at a discount. Revenue-based, asset-based or cash flow loans can also be a good option depending on a business’s particular situation. Contact Business Factors today to find the best alternative for your business.
Factoring is also known as invoice factoring or accounts receivable financing. It is the sale of pending invoices at a discount to a third-party financing company, known as a factor, or to a bank. Unlike more traditional financing options – that take into account a business’s credit score or history – factors mainly consider the creditworthiness of the business’s clients. To evaluate that, a factor runs a credit check on the business’s clients.
The price of factoring depends on the clients’ creditworthiness, the industry in question, and the number and dollar amount of the invoices to be factored, among other things. The invoices to be sold to the factor must not be pledged as collateral for a loan or encumbered in any other way.
To better understand the factoring process, please visit our Frequently Asked Questions page.
A factor can purchase just one or two invoices, in a transaction known as spot factoring, or all of the invoices in a whole-ledger or full-turn factoring arrangement. Invoices can be bought on a recourse or non-recourse basis. If unpaid invoices are bought on a recourse basis, the factor agrees to extend funds against the invoices for a specified time period. If, after that period, the invoices are not paid, the client must replace them with new ones or repay the factor. In a non-recourse factoring scenario, the factor buys the invoices outright and absorbs the loss if they are not paid. However, that risk is minimized because factors do not buy past due invoices.
Upon the purchase of the invoice, the factor advances the business portion of the invoice. The factor holds the rest back as a reserve. The discount rate—the factor’s fee for its services—typically ranges from 1% to 5%.
To get a quote for a factoring arrangement, please contact one of our executives today.
Here is an example of a factoring arrangement:
- Invoice amount: $200,000
- Advance rate: 95%, or $190,000
- Reserve: 5%, or $10,000
- Fees: 1% every 10 days
- Type of arrangement: Non-recourse
In the example above, a technical consulting business has billed one of its clients $200,000 for a recently completed project. The client has 30 days to pay, but the consulting company needs cash to make payroll and invest into another project. The company decides to sell the invoice to a factoring company at a cost of $2,000 (1%) every 10 days until the invoice is collected. The factor collects on the invoice after a month, costing the company $6,000. Once the invoice is paid, the reserve – less the $6,000 factoring fee – is returned to the client.
Supply chain financing (SCF)—also known as reverse factoring—is the sale of a supplier’s invoices to a third party, such as a bank or a financing company. Unlike factoring, supply chain financing is initiated by the buyer in the original transaction. The buyer creates a technology platform through which the supplier can select which invoices it wants earlier payment on. In exchange for this earlier payment, the supplier gives the buyer a discount on the invoice. Because the transaction is initiated by the buyer, the fee for an SCF transaction might be lower than that for factoring.
However, some SCF arrangements come with covenants that can harm a supplier’s business. For example, they may require it to disclose confidential information that may be shared with the buyer or they may make it hard to end the arrangement. In such cases, factoring may be a better option because it allows the supplier to maintain control over its business. To see why factoring can be beneficial for your business, please visit our Payroll Factoring.
Supply chain financing may come with covenants that can harm a supplier’s business. For example, they may require it to disclose confidential information that may be shared with the buyer or they may make it hard to end the arrangement.
Many types of loans can be used for information technology financing, for example, when a business wants to purchase IT equipment or software or bring in more talent. As noted on our Revenue-based Loans page, any commercial loan is likely to come with a collateral filing, such as a UCC lien in the U.S. or a PTSA/GSA filing in Canada.
Some of the most common types of loans are described below. To find the best working capital option for your business, contact one of Business Factors’ executives today.
The Small Business Administration (SBA) is an agency of the U.S. government that backs loans for small business owners so that banks and other lending institutions are fully protected when they provide loans to early-stage or less-established businesses. SBA does not extend the funds directly.
The SBA offers a variety of loan programs. Some of the more popular options are the 7(a), the Microloan, and the SBA Express. Borrowers must meet a set of requirements, including showing the ability to repay.
Revenue-based loans are loans that are extended on the basis of historical and expected revenue. They are a good alternative for businesses that are light on assets but have sufficient repayment capacity as demonstrated by historic and expected revenue.
In general, lenders for revenue-based loans prefer to work with companies that have been in business for over a year, have steady income flows, and have at least $100,000 earnings before income, tax and depreciation of assets.
Read more about revenue-based loans here.
Working capital loans are extended to fund working capital. They can be secured or unsecured. Securing can be done with assets, such as accounts receivable or equipment. To learn more about asset-based loans, please visit our Asset-Based Lending page.
To learn more about working capital loans, click here.
Cash flow loans include many types of loans used to finance everyday expenses. To learn more about them, please visit our Cash Flow Loans page.
IT finance options include many alternatives, such as factoring, supply chain financing, loans and venture capital. Factoring is the sale of accounts receivable at a discount to specialized factoring companies or banks. It is a quick way to obtain working capital that can be used to optimize a company’s cash flow. The two main qualifying criteria are creditworthy customers and receivables not pledged to a lender or otherwise encumbered. Supply chain financing, or reverse factoring, is a factoring alternative but it may come with reporting requirements or other restrictions that can hurt a business. Loans offer another way to finance IT expenditures, with asset-based, revenue-based, cash flow or working capital loans. Contact Business Factors today to find the best alternative for your business.
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