Published on 1 March 2011 by Tony Groom

Factoring and invoice discounting (borrowing money against invoices) can be a helpful tool for funding the working capital of a business.

While it used to be regarded as a means of borrowing by businesses in financial difficulties, it is now a common source of finance for managing cash flow and has the additional benefit of imposing discipline on the collection of outstanding sales invoices.

The service charge fee is pre-agreed with the finance provider and generally relates to the level of service provided which could include the collection of book debts and different levels of underwriting risk of bad debts. In addition the client is made aware of any arrangement fees and that interest on funds drawn is also applied.

Other considerations that may be taken into account when fixing the service charge fee include volume of invoices, value of invoices, percentage drawn down, maximum amount borrowed, the level of monitoring necessary and whether all or only part of the sales ledger is assigned.

The service charge fees for factoring are generally at a higher rate of between 0.8% and 3%, than for invoice discounting because the factoring service charge includes debt collection. Invoice discounting is generally cheaper because the company collects its own invoices.

However, a number of other fees are also included in the finance document and these have become a great source of revenue for lenders. Hidden in the small print, contingency fees are included that can be triggered by a default. These fees are sufficiently large to justify some lenders looking for reasons to trigger them.

There are many examples of companies in financial difficulties where the factor or invoice discount provider pull the plug on a facility and collects in the outstanding debts to recover funds loaned as well as their retaining the default and recovery fees.

Typical fees that might be applied are a default fee of 10% of the ledger held plus recovery fees which are generally not specified. Such is the scope for earning fees that advisers to lenders might be persuaded to recommend the exercising of rights under a default knowing that they, as advisers, can be paid out of the recovery fee clause as well as repaying their lender client the loan and default fee.

Turnaround advisers often find themselves having to negotiate on behalf of companies with factors and invoice discounters to persuade them not to pull the plug when, although the money loaned is covered, the real reason is to trigger default fees.

Such self interested behaviour may swell the coffers of lenders but it doesn’t help preserve businesses or improve the reputation of the finance community.