TL;DR: Many UK startups can use invoice factoring to access cash tied up in unpaid invoices, provided they trade with other businesses. While it offers immediate liquidity, it involves fees and may impact customer relationships if not managed carefully.

Can startups use invoice factoring?

Starting a new business is an exciting journey, but it often comes with a common hurdle: cash flow. In the early stages of a company, you may find that your cash is tied up in unpaid invoices. While you have completed the work and billed your clients, waiting 30, 60, or even 90 days for payment can hinder your ability to pay staff, buy stock, or invest in growth. This leads many new entrepreneurs to ask: can startups use invoice factoring?

The short answer is yes. Invoice factoring is a flexible form of business finance that is often more accessible to startups than traditional bank loans. Because the funding is secured against the value of your outstanding invoices rather than your company’s long-term trading history, it is a viable option for businesses that are only a few months old. However, there are specific criteria and risks that you must understand before proceeding.

How invoice factoring works for new businesses

Invoice factoring is a type of asset-based finance where a business sells its accounts receivable (invoices) to a third-party company, known as a factor. For a startup, the process typically involves three main parties: your business, your customer, and the factoring provider.

The process generally follows these steps:

• Your business provides a service or product to another business and issues an invoice.
• You “sell” this invoice to the factoring company.
• The factor typically advances around 70% to 90% of the invoice value to you within 24 to 48 hours.
• The factoring provider takes over the “sales ledger” management, meaning they handle the collections and chase your customers for payment.
• Once your customer pays the invoice in full to the factor, the factor releases the remaining balance to you, minus their agreed fees.

For a startup, this immediate injection of cash can be the difference between stagnation and expansion. It allows you to use your own earned money immediately rather than waiting for your customers’ payment cycles to finish.

Eligibility: Can any startup apply?

While invoice factoring is generally more accessible than a bank overdraft or a term loan, lenders still have requirements. To be eligible, your startup typically needs to meet the following criteria:

Business-to-Business (B2B) Trading: Factoring is designed for businesses that invoice other businesses or government bodies. It is generally not available for business-to-consumer (B2C) companies, such as retail shops or cafes, where customers pay at the point of sale.

Creditworthy Customers: When you apply for factoring, the lender is less concerned with your startup’s credit score and more interested in the creditworthiness of your customers. If you are invoicing reputable, established companies, a factor is more likely to provide funding because they are confident the debt will be paid.

Minimum Turnover: Some factoring companies require a minimum annual turnover, which might be anywhere from £50,000 to £100,000. However, there are specialist “selective factoring” providers who may work with very small startups or even fund single invoices.

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The benefits for startups

There are several reasons why invoice factoring may be an attractive option for a new UK business:

• Improved Cash Flow: This is the primary benefit. You get access to cash as soon as you raise an invoice, which helps cover operational costs.
• Outsourced Credit Control: Many startups do not have a dedicated finance department. Factoring companies often handle the credit control, which saves you time on chasing late payments.
• Scalability: Factoring is a flexible facility. As your business grows and your invoice volumes increase, the amount of funding available to you also grows.
• No Collateral Required: Unlike some traditional loans, factoring typically doesn’t require you to put up property or high-value equipment as security, as the invoices themselves act as the collateral.

Potential risks and considerations

It is important to approach invoice factoring with a balanced view, as it is not suitable for every business and carries specific risks.

Cost: Factoring can be more expensive than some other forms of finance. You will pay a service fee (for the administration of the ledger) and a discounting rate (essentially the interest on the money advanced). For a startup with tight margins, these costs can add up.

Customer Perception: Because the factor manages the collections, your customers will know that you are using a factoring service. While this is common in many industries, some business owners worry it may suggest the startup is in financial difficulty.

Impact on Customer Relationships: If the factoring company’s collection team is too aggressive or impersonal when chasing payments, it could damage the relationship you have built with your clients.

The Risk of Debt: If you use “recourse factoring,” you remain liable if your customer fails to pay the invoice. If a customer goes bust, the factoring company will ask for the advanced money back. “Non-recourse factoring” provides protection against bad debt but is typically more expensive. It is vital to remember that failing to manage your business finances could lead to legal action or insolvency. Your business assets or property may be at risk if repayments are not made. Possible consequences of defaulting on financial agreements include legal action, repossession, increased interest rates, and additional charges.

Factoring vs. Invoice Discounting

When researching this topic, you may see the term “invoice discounting” used alongside factoring. While they are similar, there is a key difference that matters to startups.

Invoice discounting allows you to keep control of your sales ledger. You collect the payments yourself, and your customers never know a third party is involved. However, invoice discounting is usually only available to more established businesses with higher turnovers and proven internal financial systems. For most startups, invoice factoring is the more accessible entry point into invoice finance.

You can find more detailed information on different types of business support and finance on the UK Government business finance support website.

The costs involved for UK startups

Understanding the fee structure is essential for accurate budgeting. Factoring costs are generally split into two categories:

1. Service Fee: This covers the administration of your sales ledger, credit checking your customers, and the collection of payments. This is usually expressed as a percentage of your annual turnover, typically ranging from 0.75% to 2.5%.

2. Discount Rate: This is the interest charged on the money you actually draw down. It is often calculated as a percentage over the Bank of England base rate. This is similar to the interest you would pay on a bank loan or overdraft.

Additional fees may also apply, such as setup fees, credit limit protection fees, or fees for ending the contract early. Always read the fine print of any agreement to ensure you understand the total cost of credit.

Is it the right choice for your startup?

Deciding whether to use invoice factoring depends on your specific circumstances. If your startup is growing quickly and you have a solid base of reliable B2B customers, it can be a powerful tool to fuel that growth. It bypasses the need for a lengthy credit history and provides a safety net for your cash flow.

On the other hand, if your profit margins are very thin, the cost of factoring might outweigh the benefits. You should also consider whether you are comfortable with a third party contacting your clients. It may be worth speaking with a professional financial advisor or an independent broker to compare the different facilities available in the UK market.

People also asked

What is the minimum turnover for invoice factoring?

While many providers look for a turnover of at least £50,000 to £100,000 per year, some specialist lenders offer facilities for startups with lower turnover or offer selective factoring for individual invoices.

Can I get factoring if I have bad credit?

Yes, it is possible. Factoring companies focus primarily on the creditworthiness of the customers who owe you money rather than your own credit score, though they will still perform a basic check on your business.

How long does it take to set up a factoring facility?

For most startups, setting up a factoring facility typically takes between one and two weeks, although some modern fintech providers can complete the process in just a few days.

What happens if my customer refuses to pay the invoice?

If you have recourse factoring, you are responsible for repaying the advanced funds to the factor. If you have non-recourse factoring, the factor usually absorbs the loss, provided the non-payment was due to insolvency and not a dispute over your work.

Is invoice factoring a loan?

Not exactly. While it provides an advance of cash like a loan, it is technically the sale of an asset (your invoices). This means it does not usually show up as traditional debt on your balance sheet in the same way a bank loan would.

In summary, invoice factoring is a valuable resource for many UK startups. It provides a way to unlock cash that is rightfully yours without waiting for long payment terms. By carefully weighing the costs against the benefits of improved liquidity and reduced administrative burden, you can decide if it is the right move for your business’s future. Always ensure you understand the terms and conditions of any financial product before signing, and consider the potential impact on your business’s reputation and financial health.