How Small Businesses can use Factoring as Bridge Financing

In the world of small business operations, managing cash flow can often be one of the biggest challenges. Business owners frequently find themselves in situations where they need immediate working capital to cover expenses, purchase inventory, pay employees, or invest in growth—long before customers pay their invoices. In such scenarios, accounts receivable factoring emerges as a powerful financial tool that can act as bridge financing, helping businesses stay afloat and even thrive.

This article explores the concept of accounts receivable factoring, how it works, the benefits and risks, and why it can serve as an effective bridge financing solution for small businesses.

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Understanding Accounts Receivable Factoring

Accounts receivable factoring, often simply referred to as “factoring,” is a financial transaction in which a business sells its accounts receivable (unpaid customer invoices) to a third party, known as a factor, at a discount. In return, the business receives immediate cash—typically 70% to 90% of the invoice value—while the factor takes on the responsibility of collecting payment from the customers.

How It Works

The factoring process generally follows these steps:

1. Invoice Generation: A business provides goods or services to its customers and issues invoices, usually with payment terms of 30, 60, or 90 days.
2. Sale to Factor: Instead of waiting for the invoice to be paid, the business sells the receivable to a factoring company.
3. Advance Payment: The factoring company pays a portion of the invoice value upfront—known as the advance rate.
4. Collection: The factor then collects the payment directly from the customer.
5. Remainder Payment: Once the customer pays the invoice in full, the factor remits the remaining balance to the business, minus a factoring fee (typically 1% to 5%).

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Bridge Financing Defined

Bridge financing refers to a short-term funding solution used to cover immediate cash flow needs until a business secures more permanent financing or receives expected income. It’s often used to “bridge the gap” between a financial need and a future event, such as:

• Collecting on outstanding invoices
• Receiving a bank loan
• Closing a round of equity investment
• Selling an asset or property

Bridge financing is crucial in time-sensitive situations and often carries higher costs or stricter terms due to the short-term risk for lenders.

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Why Small Businesses Need Bridge Financing

Small businesses often experience erratic cash flows. Even profitable enterprises can run into short-term liquidity crunches. Here are some common scenarios where bridge financing is necessary:

• Seasonal businesses ramping up for a busy season but needing cash to buy inventory.
• Service providers waiting 30–90 days for customer payments while needing to pay employees weekly.
• Manufacturers needing funds to cover production costs before receiving payment for completed goods.
• Startups between investment rounds but needing funds to sustain operations.

For many small businesses, traditional loans or lines of credit may not be available, especially if they have limited credit history or lack collateral. This is where accounts receivable factoring can fill the void.

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How Accounts Receivable Factoring Serves as Bridge Financing

Accounts receivable factoring fits the definition of bridge financing because it offers immediate liquidity based on income that is expected in the near future. Here’s how factoring acts as a bridge:

1. Accelerating Cash Flow

When a business issues an invoice with net 30, 60, or 90-day terms, the funds are essentially locked up for that duration. Factoring unlocks that value immediately, allowing the business to maintain operations or capitalize on opportunities without waiting.

2. Providing Short-Term Relief

Factoring provides funding until longer-term solutions are realized. For example, a business awaiting a loan approval can use factoring to maintain cash flow in the interim. Once the loan is secured, the business can rely less on factoring.

3. No New Debt Incurred

Bridge loans often come with interest and increase the business’s debt burden. Factoring, on the other hand, is not a loan—it’s a sale of assets. This makes it a particularly attractive option for businesses that want to preserve their balance sheets.

4. Flexibility and Scalability

Unlike bank loans with rigid terms, factoring is inherently flexible. The more invoices a business generates, the more capital it can access. This makes it an ideal bridge for growing businesses scaling their operations.

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Advantages of Using Factoring as Bridge Financing

1. Quick Access to Cash

Factoring companies can often approve applications and release funds within a few days. This speed is critical in time-sensitive scenarios where traditional financing may take weeks or months.

2. Improved Cash Flow Management

By converting receivables into immediate cash, businesses can better plan and manage their operational expenses without delays.

3. No Credit Score Requirements

Factoring is based on the creditworthiness of a business’s customers—not the business itself. This makes it viable for new or struggling businesses with strong accounts receivable.

4. Support for Growth Opportunities

If a business receives a large new order but lacks the funds to fulfill it, factoring can provide the necessary capital. This allows businesses to say “yes” to growth rather than turning down opportunities due to cash constraints.

5. Outsourced Collections

Some factoring arrangements include credit checks and collections, saving the business time and resources in chasing down payments.

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Disadvantages and Considerations

While factoring offers many benefits, it’s not without downsides. Business owners should consider the following:

1. Cost

Factoring fees can range from 1% to 5% or more per month. Over time, this can be more expensive than traditional financing.

2. Customer Perception

Some customers may view factoring negatively, especially if they are contacted by the factoring company. This can affect customer relationships if not handled properly.

3. Qualification Requirements

Not all invoices are eligible. Factoring companies typically only accept invoices from creditworthy customers, which may limit the amount of capital available.

4. Loss of Control

With non-recourse factoring, the factor assumes the risk of non-payment. However, with recourse factoring, the business must repay the advance if the customer fails to pay—introducing additional risk.

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Types of Factoring Arrangements

Understanding the different types of factoring is important when considering it as bridge financing.

1. Recourse vs. Non-Recourse

• Recourse Factoring: The business is liable if the customer doesn’t pay the invoice. This is cheaper but riskier.
• Non-Recourse Factoring: The factor assumes the risk of non-payment, but charges higher fees.

2. Spot Factoring vs. Full-Service Factoring

• Spot Factoring: The business factors a single invoice or a few invoices on a one-time basis.
• Full-Service Factoring: The business enters into a long-term relationship with the factor, often factoring all receivables.

3. Disclosed vs. Undisclosed Factoring

• Disclosed: The customer is informed that the invoice has been sold to a factor.
• Undisclosed: The customer pays the business, which then remits payment to the factor (also known as invoice discounting).

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Use Cases: Real-World Examples of Bridge Financing with Factoring

Example 1: A Seasonal Retailer

A toy store generates most of its revenue during the holiday season. In the fall, the business needs to order large quantities of inventory. Since customer invoices from previous sales are still unpaid, the retailer sells them to a factoring company and receives immediate funds to stock up. By December, customer payments are in, and the business is flush with cash again—making factoring a perfect seasonal bridge.

Example 2: A Construction Company

A small construction firm wins a contract to build a commercial property but needs to pay subcontractors and buy materials upfront. Bank financing is unavailable due to limited credit history. The company factors its receivables from a previous job, receives 85% of the invoice value in cash, and uses it to fund the new project while awaiting customer payment.

Example 3: A Tech Startup

A software development company with several corporate clients faces a funding gap between seed and Series A investment rounds. Though it has solid contracts and invoices pending payment in 60 days, it lacks cash for payroll and rent. Factoring those receivables helps the startup survive the interim without taking on high-interest loans or diluting equity.

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When Factoring Is the Right Bridge Financing Option

Factoring may be a strategic bridge financing option if:

• You have a predictable flow of accounts receivable.
• Your customers are creditworthy and pay on time.
• You need funds quickly to cover essential operations or fulfill new business.
• You want to avoid additional debt or can’t qualify for a bank loan.
• You are in a high-growth or seasonal industry that demands immediate working capital.

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Selecting a Factoring Partner

Not all factoring companies are created equal. When choosing a partner, small businesses should consider:

• Reputation and Experience: Choose a factor with industry experience and positive reviews.
• Fee Structure: Understand all costs, including advance rate, factoring fee, and any hidden charges.
• Recourse Terms: Know who is responsible in case of customer non-payment.
• Flexibility: Can you factor only the invoices you choose?
• Customer Service: Will the factor treat your customers professionally and protect your relationships?

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Conclusion

Accounts receivable factoring is a powerful and flexible tool for small businesses facing short-term cash flow challenges. As a form of bridge financing, it offers quick access to working capital without the burden of debt or the wait for customer payments. While it comes at a cost and involves handing over some control, the benefits—especially for businesses with steady receivables and creditworthy customers—can far outweigh the downsides.

In an economic landscape where agility is often the key to survival and success, factoring can be the bridge that helps small businesses cross from financial uncertainty to stability and growth.

Contact Factoring Specialist, Chris Lehnes

Accounts Receivable Factoring
$100,000 to $30 Million
Quick AR Advances
No Long-Term Commitment
Non-recourse
Funding in about a week

We are a great match for businesses with traits such as:
Less than 2 years old
Negative Net Worth
Losses
Customer Concentrations
Weak Credit
Character Issues

Chris Lehnes | Factoring Specialist | 203-664-1535 | chris@chrislehnes.com