Turning IOUs into cash with factoring

Often, your climate startup will deliver value to a customer, but won’t get paid right away. Instead, you’ll take on an IOU in the form of a receivable – a rebate, tax credit, or invoice. But since this isn’t cash, you can’t spend it or use it for payroll. Factoring solves this problem by allowing you to sell your receivable to someone else who will give you the cash early, but at a discount.

DR is the founder and CEO of Elephant Energy. We sat down with him to discuss the pros and cons of factoring, how to find the right providers, and tips for the negotiating process. 

Factoring: 5 things to know

1. You’re selling at a discount
The value a factoring entity will assign to a receivable depends on how high they view their chances of being repaid. You could be paid as much as 95% of the receivable, but generally will be paid in the 50-80% range. For instance, a rebate, which carries a very high likelihood that you’ll be paid back, will be more valuable than a tax credit, which could potentially run into obstacles down the line. They’ll also take into account when the receivable is due to be paid, i.e. if it’s only 30 days away the advance rate will be higher. 

2. You may be cut out of the process
Factoring is distinct from borrowing against your receivable or contract. Here, you’re transferring the rights to the invoice to the factoring company, and in many cases, your customer will pay the factoring company directly.

3. It’s not a loan
Even though it's a deferred obligation for your business and comes with a cost of financing, factoring is not formally a loan.

4. It’s on an invoice basis
You can generally only factor specific invoices on an individual basis, not the full value of the contract.

5. Fees are often included
Typically, but not always, the fees are baked into the price you’re getting for the receivable, e.g. 80 cents on the dollar. 

Not factoring vs factoring

Not factoring 

The good: If you don’t sell to a factoring company at a discount, you get the full value of the invoice.

The bad: If you don’t factor, you’ll have to wait 30, 60, 90, 180 days to get paid – sometimes a year or longer. This will slow your growth, put strain on the balance sheet, and create the risk that you can’t meet other payment obligations like payroll. 

Factoring

The good: The clear benefit of factoring is having access to cash you can spend to meet your business’s immediate needs. Factoring also makes your financials simpler, as you won’t have those receivables on your balance sheet, which could raise questions for investors. 

The bad: Critically, with factoring you’re saying goodbye to the full dollar value of your work, which you’ll need to weigh up against the benefit of getting paid earlier. There’s also extra operational work involved, especially if something goes off track and the buyer of your receivable doesn’t get paid.  In those cases, you’ll generally be on the hook to replace the invoice with another customer’s upcoming payment.

Factoring vs a loan 

If you’re considering your options with a single invoice and the pricing is comparable, factoring often makes more sense than a loan because the contract is much simpler. If you’re looking to borrow against a contract (i.e. multiple future invoices that haven’t been filed yet), a loan would likely give you more cash upfront, and save you the hassle of dealing with lots of separate invoices, but comes with much more intensive compliance requirements. It’ll often involve putting up more than just the contract as collateral, while with factoring, you’re only selling timing risk – so if the invoice isn’t paid or there’s a dispute, you can make it up.

Whether a loan or factoring is the right call also depends on your type of business. If you have a small business and don’t want to think further than the current job, you might lean towards factoring. But if you’re a larger business with multiple priorities – like R&D work and building a platform – it often makes sense to borrow a larger facility. 

Finding factoring providers

Just like looking for investors, finding factoring companies is all about networking: with fellow entrepreneurs, companies with similar business models, other people in the finance community, and your internal team. This could take a lot of conversations and you should expect to kiss a lot of frogs. When you’re speaking to lenders, look out for:

1. The price
Depending on your specific type of receivable, it might be difficult to find someone who’s willing to factor it at a decent price. It’s also worth paying more for someone who you trust and will treat you well, rather than negotiating down to the last penny and both ending up frustrated. 

2. The risk
You’ll need to assess how risk is split between you and the factoring company. Are they taking on any performance risk, or only the risk around repayment timing?

3. The process
Do you just need to send a copy of the invoice and they’ll wire you the money, or are there 10 different pieces of paperwork to fill out? 

This is the implicit cost of the process: if a factoring company is offering you 80 cents on the dollar, but it will take 10 hours of work a week, you’ll need to price that in accordingly. The workload will also depend on how many clients with receivables you’ll need to coordinate with.

4. How much your customer needs to be involved
Will the end client need to contract with the factoring company? Is the process as simple as switching the bank account, or much more complicated? 

In some cases the counterparty (i.e. your customer) may not be happy with the arrangement or allow you to factor the invoice, particularly when it comes to government grants or procurement contracts.

The negotiation process

The terms you’re offered will depend on your credibility, size, and how much money you’re trying to factor. It might not be obvious, but everything is negotiable. Shopping around will help you get the best deal, as you can play different lenders against each other.

However, remember that with debt there’s always some give and take, e.g. trading a better advance rate for higher fees. Plus, lenders are interested in repeatability, and early on, your pricing will almost always be worse than what you can secure later. Pushing too hard too soon can backfire. 

Tricks and tips for factoring

1. When in doubt, overcommunicate
Hiding information will come back to bite you. Don’t wait for a problem to become unavoidable before you let the lender know – flag it as soon as there’s a good chance something will go wrong.

If something does go wrong, remember that these lenders are typically much more flexible than banks. Your provider wants you to succeed, because it’ll be more profitable for them if you do, and most of the time triggering punitive covenants will not be worth the headache. 

2. Understanding the cash implications
If your contract is worth $1m but factoring will cut it down to $600k, this will change your burn forecast, how many people you can hire, and how much you can invest for the future. If you forget to factor in the haircut on your margin, you risk overestimating your revenue projections and coming up short.

DR is the CEO and co-founder of Elephant Energy, a one-stop shop for residential electrification across Colorado, Massachusetts, and Los Angeles. We partner with homeowners through every step of their clean energy journey—from designing the right heat pump system for their home to managing installation, financing, rebates, warranties, and ongoing service. Before founding Elephant Energy, DR was a Partner at Vision Ridge Partners, a $5B sustainable asset investor. DR started his career at Altman Vilandrie & Company, a strategy consulting firm in Boston.