Unlike a conventional loan or a traditional purchase and sale, which are agreements between two parties, a factoring transaction involves three parties — seller, buyer and factor. Unfortunately, when a seller engages in factoring, the involvement and perspective of the buyer can be lost or overlooked.
The Factoring Relationship
What begins as a conventional sale — a seller supplying goods to a customer — becomes more complicated if the buyer accepts delivery immediately and agrees to pay later. The seller remains unpaid but owns an invoice that has become a negotiable instrument to be bought and sold. In a typical factoring transaction, a factor buys the invoice from the seller, usually at a discount and with a reserve. When the buyer pays the invoice to the factor, the transaction is reconciled, and the factor returns the reserve to the seller.
Notification or Non-Notification
Factoring may be provided on a notification or non-notification basis. Full-notification factoring requires the buyer to sign a notice of assignment and submit payment of invoices directly to the factor. For the arrangement to succeed, all three parties must follow the process, and the buyer must be informed of the arrangement.
With non-notification factoring, the buyer’s involvement is greatly reduced. The seller delivers the goods or services and invoices the buyer, and the factor buys the invoice from the seller. However, the buyer is not informed that the seller has sold its invoice(s) nor does it pay the factoring company directly. The buyer does not sign a notice of assignment. Invoices are verified confidentially, and payment is sent to a controlled account in the seller’s name.
However, the majority of invoices are factored with full notification, so the buyer’s perspective is a critical concern. Despite the importance of all three parties understanding the process, working together and living up to their obligations, little time and effort is spent communicating with the buyer, who usually has no input into the arrangement. Often, the only communication the buyer receives is a form letter explaining that its supplier, the seller, has entered into a factoring agreement, and the buyer is required to sign a legally binding notice and redirect payment to the factor.
The buyer’s role is critical in successful full notification factoring. So one of the most common questions a seller asks when contemplating factoring is, “What will my customers think if I factor my receivables?” Most factoring companies provide standard responses to reassure their clients that it will not be an issue for their customers, including:
- Factoring is a well-known form of financing, and it is unlikely that you are their only supplier factoring.
- It is an indication of your strength and growth.
- All companies need financing; this is just another form of financing.
- It enables you to provide your customers with payment terms.
But are these responses sufficient to reassure a buyer who is not familiar with factoring?
The Buyer’s Perspective
To examine this often-neglected perspective, buyers’ representatives were asked about their perceptions of factoring. Although all interviewees were familiar with factoring, it was — contrary to the reassurance of many factoring companies — generally negatively perceived. When notified of a supplier’s intention to factor, most buyers questioned the financial strength of the suppliers. Signing notices of assignment, redirecting payment and duplicate invoicing was viewed as additional work for the buyer. Based on these findings, greater attention should be given to the perspective and involvement of these third parties.
To further understand how buyers view the factoring relationship, 12 representatives responsible for accounts payable from a cross section of small, mid-sized and large companies were asked the following five questions to determine what they think when a supplier informs them of their intention to factor:
- To your knowledge, have any of your sup-pliers factored invoices payable to you? If yes, how many?
- Is your company willing to sign factoring notices of assignment and redirect payment to factoring companies?
- From your perspective, what are the benefits of your suppliers factoring your payables?
- What do you think when a supplier asks you to factor their invoices? Does it have any impact on your business relationship with them?
- What can your supplier and/or the factoring company do to make it easier for you?
This survey does not claim to be statistically valid, but it does provide anecdotal insight into the thoughts of the third party in the factoring relationship — the buyer.
All the respondents were acquainted with factoring. Though not widespread among their supplier base, eight of 12 respondents reported working with at least one supplier that factored their invoices either currently or in the past. All respondents who never had a supplier factor were from companies that were unwilling to participate in factoring arrangements.
The survey revealed a company’s willingness to sign a factoring agreement was directly correlated to its size. The smaller the company, the more likely it was to sign.
The office manager of a small telecom service provider explained, “We’re a small company and don’t get many requests. It would be more of an issue if I had a lot of requests.” This response differed dramatically from the answer of an accounts payable manager from a large manufacturer, “Even if I wanted to, I couldn’t, and I doubt our CFO would agree.” The manager of supplier relations at a large international retailer responded,“We won’t sign anything, but our vendors can revise payment instructions through the portal.”
None of the buyers saw any benefit to their companies from factoring. “I do it to help out my suppliers,” was one response.
When asked, “What do you think when a supplier asks you to factor their invoices?” the buyers’ responses were generally negative. Seven respondents from different-sized companies stated that the choice to factor made them wonder if their supplier was in trouble. The office manager from a mid-sized communications company noted, “It’s no big deal if they are a once-in-a-while supplier. I would worry if it’s a critical supplier.” Another accounting manager from a mid-sized manufacturing company said, “It makes me nervous, what if they can’t deliver on time?” The most positive comment was from the office manager of a small telecom service company who said, “It’s not a big deal. Not many suppliers are doing it, so it’s easy for me to flag in our system. If it was happening a lot, it would be harder to track.”
When asked what a supplier and/or factoring company could do to make it easier for the buyer, responses included, “Factoring companies can be very aggressive in calling. Our payables are currently 60 to 80 days, and I am getting calls and emails from both the factoring companies and suppliers. Some are worse than others.” An accounting and payroll administrator from a mid-sized logistics company observed, “There is sometimes miscommunication between carriers (sellers) and factors. Sometimes a carrier sends an invoice and then two weeks later I get the same invoice from the factor. Who am I to pay? Factors and carriers need better communication. It can be very confusing.”
Conclusion and Next Steps
Since successful factoring agreements need all three parties to work together, factoring companies and sellers need to do a better job explaining the benefits to the buyers. Smaller companies receive the arrangement more willingly as do sellers who have a personal relationship with the buyer. Leveraging such relationships, by having the seller introduce factoring and by providing the buyer with a professionally worded notice, can alleviate the buyer’s concerns. Communicating with buyers in a professional and coordinated manner is critical.
For the buyer, a simple process is essential. To reach that point, factoring companies must invest in, and use, technology to reduce the buyer’s workload and eliminate the duplication of invoicing. They need to innovate and consider alternative structures, such as non-notification factoring, to eliminate any stigma regarding the financial strength of their supplier. It is the factor’s responsibility and duty to treat the seller’s customer as if it were its own.