What is Construction Factoring?
Factoring is a form of construction financing where a business sells unpaid invoices for an immediate cash advance. It’s also called invoice factoring, accounts receivable financing, or simply factoring receivables.
The construction industry finds factoring particularly useful because contractors and subcontractors often wait weeks or months to get paid. But the operating costs of running a construction company are high.
Many construction companies require immediate capital to cover payroll, manage supplier payments, or seize growth opportunities. Invoice factoring enables construction companies to maintain financial stability by ensuring they can pay employees and suppliers on time.
When a business lacks sufficient cash flow to support its daily operations, it risks going out of business. With factoring, construction businesses can ensure they have the working capital to keep the job running smoothly.
Businesses can utilize factoring for both residential and commercial construction projects. Many construction subcontractors also use factoring to cover their operating expenses.
How does Construction Factoring work?
The process for factoring construction receivables requires working with a third-party company, commonly referred to as a factoring company or Factor. The factoring company purchases the invoices at a discount and sends a cash advance based on the invoice value. It is common for factoring companies to advance between 80% and 90% of the invoice’s face value once it is accepted. Most discount rates range from 1% to 5%.
The factoring company owns the invoices and waits for clients to settle their accounts. Once the client pays, the factoring company releases the remaining amount to the construction business.
Construction Invoice Factoring Steps
Once a construction business has a factoring agreement, the steps go as follows:
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Perform the construction services and invoice the client.
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Send the invoice to the factoring company for approval.
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The factoring company approves the invoice and buys it at a discounted price.
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The factoring company then sends cash based on the advance rate.
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The remaining balance goes into a reserve account.
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The client pays their invoice directly to the factoring company.
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After receiving payment, the factoring company releases the reserve amount.
Invoice Factoring for Construction Example
ABC Construction has a factoring agreement with the following terms:
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Advance rate: 85%
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Discount rate: 3%
The business factors invoices worth $100,000. The factoring company applies the 2% discount and purchases the invoices for $98,000.
It then applies the 85% advance rate and issues a cash advance of $83,300. ABC Construction receives the advance via wire transfer in 24-48 hours.
The remaining $14,700 goes into a reserve account. The factoring company waits for ABC’s clients to pay their invoices.
Once the factoring company receives payment, it releases the remaining balance minus any additional fees.
What is a Construction Factoring company?
A factoring company is a financial institution that provides factoring services. Most construction factoring companies are fintech businesses.
Factoring companies vary in their pricing, conditions, and policies. Let’s examine some of the key differences between various factoring companies.
Fee Structure
The primary factoring fee is the discount rate, also known as a factor or factoring rate. It is a sales discount for the factoring company. Most factor rates range from 1% to 5%, depending on the company.
Many factoring companies charge additional service fees. Some standard factoring fees include:
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Origination or initial filing fee: A one-time fee charged at the start of the factoring process.
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Lockbox Fee: AKA a monitoring fee, it’s an extra fee for monitoring the reserve account. Most of the time, it’s unnecessary unless it significantly reduces the factor rate.
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Monthly minimum volume fee: A fee charged if a company fails to meet a defined monthly volume of invoices (measured in dollars).
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Monthly access fees: Some factoring companies charge extra to access the provided software.
Recourse vs. Non-Recourse Factoring
Recourse factoring is the most common type, meaning that a business that factors its construction invoices is responsible if a customer fails to pay. In such cases, the factoring company requires the invoice seller to repurchase the invoice. The seller can then try to collect the late payment or send it to a collection agency.
Non-recourse factoring offers protection against non-payment by customers under specific circumstances. The non-recourse agreement defines what conditions exempt the invoice seller from recourse. For example, most non-recourse contracts include no fault if the customer fails to pay due to bankruptcy.
Non-recourse factoring typically involves a higher factor rate and a lower advance rate, as the factoring company assumes a greater level of risk. Non-recourse usually doesn’t apply when customers refuse to pay or dispute the contract or amount owed.
Notification Factoring
Some factoring companies notify the invoice seller’s customers when they take over credit control. The notification makes it easier for the factoring company to collect. Some businesses don’t want to jeopardize the customer relationship with notification factoring. If this applies to your construction company, look for a factoring company that doesn’t require notification. Invoice factoring through UCS doesn’t use notification.
Industry-Specific
Some factoring companies specialize in serving specific industries, such as the trucking and transportation sectors. Consider looking for a factoring company that specializes in construction factoring.
Additional Services
Some invoice factoring companies stand out because they offer enhanced services to help you process invoices. Some additional services to consider when looking for a factoring company include:
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Easy invoice uploads.
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Integration with your accounting software.
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Credit checks on your customers.
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A/R processing tools.
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Online portals or mobile apps for convenient processing.
How do Construction Companies qualify for Invoice Factoring?
Approved businesses we work with here at UCS typically meet the following minimum qualifications:
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Annual Revenue: $250k+
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Credit Score: 550+
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Time in Business: 1+ years
To initiate factoring, companies must usually complete a specific application process with the factoring company. Factoring companies often require an accounts receivable aging report to assess the eligibility of invoices for factoring. Eligibility for invoice factoring typically requires a minimum of one year of business experience.
Credit checks on clients are commonly performed by factoring companies to assess the likelihood of payment. Construction companies need to provide a list of existing and potential customers to qualify for factoring.
Many factoring companies do not accept invoices from delinquent customers or those with limited credit profiles. Factors may file a UCC to secure the collateral when establishing a factoring agreement.
How to apply for Construction Factoring:
You can apply for invoice factoring through United Capital Source. Follow these instructions to apply.
Step 1: Make sure your customer is reliable.
Construction factoring only works when your customers pay on time and in full. Ensure your customers will pay.
Step 2: Gather your documentation.
When you apply, the Factor needs to review the following documents:
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Driver’s license.
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Voided business check.
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Bank statements from the previous three months.
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Business tax return.
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Accounts receivable aging report, Accounts payable report, and debt schedule.
Step 3: Apply.
You can complete our one-page application or contact us by phone to apply. Either way, you’ll need to provide the information above and the invoice amount you want to sell.
Step 4: Speak to a representative.
Once you apply, one of our representatives will contact you to discuss the factoring rate and terms associated with the sale. You’ll get an upfront breakdown of all costs, so you don’t have to worry about hidden fees.
Step 5: Receive approval.
The entire process takes about two weeks to finalize. Funds will appear in your bank account 1-2 days after completing the application.
What are the advantages of Invoice Factoring for Construction?
The lower credit approval requirement means that small businesses, such as some construction companies, can qualify for small business factoring when they are unable to obtain another small business loan. Some contractors and subcontractors use invoice factoring as a bridge financing option until they have established enough business history to qualify for larger loans, such as a construction equipment loan.
The most significant benefit is converting accounts receivable into working capital. Cash is the lifeblood of any business, and healthy cash flow keeps your business building.
Tracking down payments from customers, processing payments, and staying on top of billing requires time and effort. Some construction businesses benefit from the fact that the factoring company handles the billing and payment processing after they acquire the invoice.
What are the disadvantages of Construction Factoring?
The main disadvantage is the cost of factoring. Factoring rates usually cost more than an APR for a traditional loan.
The factor rate a business receives depends on how quickly customers pay their invoices. For example, a net-30 invoice will have a lower factor rate than a net-90 invoice.
Factor rates also continue to drive up costs when customers pay late. If your business has a factor rate of 2% for net 30 invoices, it applies each time the customer is late with payment. Therefore, it applies when you first factor the invoice, and payment is due within 30 days. On day 31, the factoring company charges another 2%. On day 61, another 2%, and so on.
Pros & Cons:
Pros:
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Turn unpaid invoices into cash.
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Easier to qualify for than other business financing options.
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You can use the funds for various business purposes.
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Invoices are collateral.
Cons:
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Higher rates & fees than traditional loans.
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Fees are based on the time it takes insurers to pay their invoices.
Frequently Asked Questions
Here are the most common questions about factoring construction invoices.
Why do Construction Businesses Use Factoring?
Invoice factoring offers several benefits to construction contractors.
Early Access to Working Capital
Invoice factoring primarily aims to convert outstanding invoices into immediate working capital. Having the funds to cover construction costs helps businesses bridge the gap between providing services and receiving payment.
Stabilize Cash Flow
When customer payments are unpredictable, so is our budget. Factoring invoices allows you to know exactly when you’ll be paid and how much. The ability to convert invoices into cash helps to establish a reliable cash flow and stay on top of daily expenses.
Covering Payments
Construction companies face operational costs that are often non-negotiable. Having extra cash can help construction businesses stay ahead of the competition. The amounts available through construction factoring can grow as the business’s sales increase.
Can I get Construction Factoring with bad credit?
Obtaining approval for invoice financing is possible even with a poor credit history. Since the factoring company receives payment from your customers, it prioritizes their credit more than yours.
Some factoring companies have very low credit score requirements, while others don’t. However, your customers must have good credit and be reliable.
How does Invoice Factoring compare to other Construction Business Financing Options?
Construction factoring is just one of many business financing solutions available to contractors and subcontractors. When deciding on the best funding method for your business, it’s essential to understand how factoring compares to traditional loans, lines of credit, merchant cash advances, and equipment financing.
vs. Traditional Business Loans
Traditional loans from banks or credit unions typically offer lower interest rates than factoring. Bank loans generally require more stringent qualifications and a longer repayment commitment compared to construction factoring. In contrast, factoring relies on your customers’ creditworthiness—not your own—and offers fast access to working capital.
Best for: Businesses with strong financials and time to wait for funding.
Factoring advantage: Easier approval and quicker funding, especially for companies with poor credit or limited financial history.
vs. Business Lines of Credit
Lines of credit offer revolving capital you can draw from as needed. While flexible, they often come with strict approval standards, usage limits, and may require collateral.
Construction factoring, on the other hand, provides immediate funds based on outstanding invoices, with no fixed borrowing cap. The amounts available through construction factoring can grow in tandem with business sales, making it a scalable solution.
Best for: Ongoing access to funds for various expenses.
Factoring advantage: Scales with sales and doesn’t require perfect credit or extensive documentation.
vs. Merchant Cash Advances (MCAs)
MCAs provide lump sums in exchange for a percentage of future sales, which is repaid on a daily or weekly basis. While they’re easy to qualify for, MCAs often carry high fees and can strain cash flow.
Factoring typically costs less than an MCA and doesn’t depend on future card sales, making it a more predictable option for B2B businesses.
Best for: Businesses with strong daily credit card sales.
Factoring advantage: Lower costs and more transparency.
vs. Equipment Financing
Equipment financing enables you to purchase or lease machinery and tools over a specified period. While it’s great for acquiring fixed assets, it won’t help with cash flow or project delays due to unpaid invoices.
Factoring frees up capital tied in receivables, helping cover payroll, materials, or operational costs, especially when waiting on payments from general contractors.
Best for: Purchasing new or used equipment.
Factoring advantage: Improves liquidity without incurring long-term debt.
Invoice Factoring for Construction – Final Thoughts
Construction factoring is a viable business financing option for companies that require assistance with cash flow. The costs run higher than a traditional business loan, but it’s easier to qualify, and you use your assets instead of incurring business debt.
Construction businesses with good credit or those requiring larger loan amounts should consider alternative business loan options. Companies that use construction factoring often view it as a temporary bridge financing solution.
However, some companies prefer the factoring partnership since factoring companies handle billing and payment processing. Some factoring companies also offer additional accounts receivable management services.
Ensure you research your best options to find a factoring service and rate that works for your business needs. Look out for hidden fees in the factoring agreement and ensure you understand the terms and conditions.
Contact us to discuss your construction factoring options with United Capital Source. Our financing experts will provide a complete breakdown of costs, so you don’t have to worry about hidden fees.
