Factoring and Invoice Discounting: Be Wary of Hidden Fees

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. 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.

However, hidden in the small print are usually contingency fees 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 default fee are 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.

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.

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