There are a few bad actors in this industry.
Given that most of the industry is not regulated, the industry and marketplace does a very good job of self regulating itself. The vast majority of commercial finance companies are responsible businesses that help provide capital and credit to businesses that are fast growing or that have had an uneven history of profitability. There are a few bad actors in this industry and business owners that have been burned by unscrupulous companies tend to paint the entire industry with a negative broad brush of corruption.
This week I heard a story from an Austin Texas company about the common unscrupulous practice of filing a UCC-1 financing statement against it by a Central Texas based factoring company before they had agreed to do business together.
The potential borrower had talked to and made application to the factoring company but chose not to use them. The company kept a copy of an application they made to the factoring company but couldn’t find any language on the application that authorized the factoring company to file a UCC-1 against them.
Factoring companies that use this practice typically tell potential borrowers they must pay “due diligence and termination fees” to have the UCC-1 terminated. Businesses are often at the mercy of the unscrupulous factor. Often the amount to have the UCC-1 terminated is far in excess of what the due diligence fees actually cost. I have seen termination fees cost up to $3,500.00 when the real costs may be twenty times less.
Fortunately in the case of the fast growing
Here are a few tips to avoid unscrupulous factoring companies that serve the bulk of the small business end of this industry:
Get quotes from several factoring companies, not just one. Use a comparison checklist to help you compare the differences between companies. There can be many terms and costs that differ from factoring company to factoring company.
Call at least a few customer references of the factoring company. Pick references that have been using the factor for at least 2 years to call. Ask if thy had experienced any surprise fees or hidden costs during their time with the factor. Ask if the factoring company sales person disclosed all the fees that the customer is paying before the relationship began.
Be cautious of factoring companies that want to obligate you to a multi-year contract. It may be reasonable for very large companies that need factoring and where there is a substantial discount being offered by signing a 2 year contract. I would strongly avoid signing a 3 year contract. The best contracts are with factoring companies that use a month to month contract. That means you can leave them with 30 days notice (or vise versa).
Do not sign an application in the beginning. Fill it out accurately and attach a letter saying that you will sign the application if and when there is an acceptable term sheet offered to you. By not signing their application, the factoring company cannot access your personal credit. You will eventually have to agree to give the factoring company that is your final choice authorization to access your personal credit, but you don’t want this during the “shopping” phase.
As part of your due diligence of a factoring company ask them for a sample copy of their legal documents at the beginning of the discussion. They should be readable by the average business owner. The most reputable factoring companies use simple easy to read agreements. Make sure if you don’t understand what you are reading, you have an attorney help you.
Sam Thacker is a partner in Austin Texas based Business Finance Solutions
You may reach him directly at [email protected]