Invoice financing allows startups to get cash quickly by selling their outstanding invoices to a third-party financing provider, or lender, typically at a discount. The lender then advances a percentage of the invoice value, often between 70% and 90%, providing startups with immediate working capital. Invoice financing is useful for startups looking to improve cash flow, smooth seasonal demand, or take advantage of growth opportunities without taking on additional debt.
What Is Invoice Financing?
Invoice financing (some circles also refer to it as invoice finance, invoice discounting, or debtor finance) is a way for startups to borrow capital from their unpaid invoices. As opposed to invoice factoring where startups sell their receivables at a discount to an invoice financing company, with invoice financing, they still retain ownership of the underlying invoices. Thus, the end customer pays the invoice to the company, who in tern pays the financing company back.
Non-recourse factoring is another type of invoice financing where the financing company assumes the credit risk of the invoice. If the customer doesn’t pay the invoice, the financing company absorbs the loss rather than the startup that sold the invoice.
The amount of a startup’s annual revenue is a major factor in the amount of invoice financing it may be eligible for.
The Application Process
Applications for invoice financing involve applying to a lender or financing company. The startup will need to provide copies of the outstanding invoices that the business wishes to finance. The lender reviews the application and underlying financials of the startup to determine if they are qualified for financing, and the amount of capital they can access.
The approval process for invoice financing is faster than traditional bank loans, as the lender’s decision depends on the value of the outstanding invoices, the creditworthiness of the business’s customers, and the underlying financial health of the startup applying for the financing.
Invoice financing vs SBA loans
SBA loans are backed by the US Small Business Administration (SBA) and are designed to help small businesses access financing. The SBA doesn’t lend money directly to startups but guarantees a portion of the loan provided by approved lenders. Unlike invoice financing, with SBA loans the business must undergo a rigorous qualification process including providing a business plan, providing financial projections and collateral.
How Does Invoice Financing Work?
Invoice financing allows startups to immediately access the cash tied up in their invoices rather than waiting for customers to pay. With invoice financing, startups can finance the underlying value of their receivables (invoices) at a discount to an invoice financing provider. The lender pays the business upfront for the invoices, often within 24 hours. The customers pay the startup, and the startup makes monthly payments to the lender.
Why Is Invoice Financing Used?
Most startups sell products or service contracts to large customers (retailers, other types of businesses, etc.) on credit. The end customer pays the invoice after some time (often 30, 60, or 90 days), but the startup needs to pay its suppliers immediately. This creates cash flow problems for startups, as they must wait for customers to pay before accessing the working capital. By financing the outstanding receivables, startups can almost immediately access the value of these contracts, which is helpful for smoothing the cash flows.
What Do Startups Use Invoice Financing For?
Startups often use invoice financing to free up working capital to reinvest in the business or take advantage of opportunities. It can also be used to pay suppliers on time, which helps them get better terms from their suppliers in the future.
Some other common uses for invoice financing include:
- Investing in product development, hiring additional staff, or expanding operations.
- Cover unexpected expenses, such as repairs or legal fees
- As a bridge between their next equity capital raise
Can You Provide An Example Of Invoice Financing In Action?
Suppose Company A sells products to Company B on credit. The invoice is for $100,000 and is due in 90 days. Company A needs the cash to pay its suppliers immediately but won’t receive payment from Company B for another three months.
To solve this problem, Company A uses invoice financing to unlock $90,000 within 24hrs. They receive the funding immediately and pay back $16,666.67 per month for the next six months to the lender.
What Are The Benefits Of Raising Capital Via Invoice Financing?
There are several benefits that startups receive by leveraging invoice financing, including
- Improves cash flow - Invoice financing gives startups access to the cash tied up in their receivables, improving cash flow and making it easier to manage day-to-day expenses.
- Flexible - Startups can choose how much of their receivables they want to finance, and they only pay interest on the amount of capital accessed. This makes invoice financing a flexible way to access capital.
- Unsecured - Invoice financing is often unsecured, meaning startups don’t need to provide collateral to qualify. This makes it a good option for companies that don’t have hard assets to use as collateral.
- Ideal for B2B Startups - Invoice financing is particularly well-suited for B2B (business-to-business) companies, where it is common for invoices to have long payment terms. B2B businesses typically have to wait for 30 to 90 days to receive payment for goods or services they have delivered, which can create cash flow problems and hinder their ability to grow.
What Are The Drawbacks Of Raising Capital Via Invoice Financing?
Despite the many benefits, there are also some cons of invoice financing that startups should be aware of, including
- High-interest rates - Because this type of financing is a form of short-term lending, the interest rates are often higher than for other kinds of loans. This can make it a more expensive option for startups.
- Costly - In addition to interest, startups might have to pay factoring fees to the invoice financing company. These fees can vary depending on the company, so it’s important to compare different options before choosing one.
- Potential cash flow issues - If collecting payments is challenging due to customers being late with invoice payments, startups may have to pay additional fees to the invoice financing company. This can cause cash flow problems and put startups in a difficult financial position.
What Are The Typical Terms Of Invoice Financing?
The terms of invoice financing can vary depending on the lender, but there are some common features:
- The loan amount is usually based on a percentage of financed invoices. The exact rate can vary, but it is typically between 70% and 90%.
- The loan term is how long the business has to repay the loan. The period can vary but typically between 180 and 365 days.
- The interest rate is the cost of borrowing money and can vary depending on the lender. Rates are typically between 12% and 18% APR.
Can You Negotiate The Terms Of Invoice Financing?
The terms of invoice financing are typically negotiable, so startups should compare different lenders to find the best deal. It’s also important to remember that the interest rate is only one part of the cost of borrowing money, so startups should also compare the fees charged by different lenders before deciding who to work with.
What Are The Financing Alternatives To Invoice Financing?
There are several financing alternatives that startups can consider, including:
- Lines of credit - Lines of credit generally have lower interest rates than invoice financing, but they can be more difficult to qualify for. When obtaining lines of credit, a business’s creditworthiness is a critical factor that lenders consider.
- Equity capital - The term ‘equity financing’ refers to a funding arrangement where an investor provides capital to a startup in exchange for equity or stock in the company.
- Venture debt - Venture debt is a form of debt financing used by startups and early-stage companies to cover short-term operating expenses, support market expansions, and bridge the gap between venture rounds.
What Are The Differences Between Invoice Financing And Invoice Factoring?
Invoice financing and invoice factoring are two similar but distinct products. The main difference is that with invoice financing; startups retain ownership of their invoices. With invoice factoring, companies sell their invoices to the lender.
Another difference between invoice financing and invoice factoring services is that with invoice financing, startups typically make repayments over time. With invoice factoring, startups usually receive a lump sum of cash upfront from the invoice factoring company, which is then responsible for collecting payments from the end customer.
Invoice Financing: Yes Or No?
Invoice financing can be a good option for startups that need quick access to cash. It’s incredibly flexible, the amount of available capital is only dependent on the outstanding invoices a startup has, and there are no warrants, covenants, or personal guarantees. Before deciding who to work with, it's important to compare the total cost of capital and the terms of different lenders in apples to apples manner. If you’re interested in invoice financing, check out a similar product called revenue-based financing that we offer.