Therefore, if you’re trying to decide between small business loans and invoice factoring, you’re not going to find a simple, black and white answer. What you can find, though, is an understanding of both funding options and how they compare so you can determine which suits your business best. To help you choose between small business loans and invoice factoring, this post will review what they are and how they differ from each other.
What is a Small Business Loan?A small business loan is a loan from a bank, credit union, or alternative lender for a specific amount with a predetermined repayment schedule. Small business loans come with either a fixed or floating interest rate. Small business loans usually have regular, monthly payments and a maturity date. On the maturity date, the loan balance must be fully repaid. In most cases, small business loan terms are greater than one year. Small business loans are generally secured by collateral and require a personal guarantee.
What is Invoice Factoring?To start, we'll explain how invoice factoring works, so you can determine if it's worth applying for. Invoice factoring companies pay you a lump sum of cash based on a percentage (also called a factor) for your unpaid invoices. Depending on how the invoice factoring is structured, you may receive all of the cash upfront or a portion. In the latter scenario, you’ll receive the rest of your cash when your customers pay off their outstanding invoices. In the event your customer fails to pay the invoice, it depends on the factor type whether or not you’re liable. On a non-recourse factor, you’re liable for any non-payment, but on a recourse factor, the factoring company is liable. In either case, you’ll receive a lump sum of cash in a matter of days. However, you’ll be charged a factoring fee (also called a discount rate) which typically ranges from 10 to 30 percent of the invoice total.
Small Business Loans vs. Invoice FactoringEven though they’re completely different types of additional working capital, both invoice financing and small business loans are useful to many entrepreneurs. To help you determine which is the best fit, the following section will compare these financing options based on their:
- Application processes
- Eligibility requirements
- Allowed use of funds
Application ProcessesThe application process for invoice factoring is much quicker than it is for small business loans. A small business loan may take months to fund. Invoice factoring can put money in your account in a matter of days. That said, not all small business loans are created equal. If you’re applying through an online lender, you can get your loan funded in only a few days. It’s the traditional institutions, such as banks and credit unions, that can take a month or more to approve your loan.
Eligibility RequirementsDue to their different structure, the eligibility requirements of invoice factoring vs. small business loans are distinct from each other. Invoice factoring companies are chiefly concerned with:
- Your customers’ credit score
- Invoice amount
- Your sales volume
- Factor type
- Credit history
- Company revenue
- Time in business
- Debt to income ratio