Raising money from Business Angels and, increasingly, crowdfunding is a critical first step for launching a startup.
However, once your startup begins to create revenue then you will typically be looking at additional funding. This might come from a second round of venture capital funding (ie cash for equity) or bank funding (although this is unlikely), peer to peer lending or invoice discounting.
A key challenge facing young businesses – and especially those working in the business to business sector – is cashflow.
During a recession invoice take longer to be settled – so if you agree terms of 30 days, it is wise to plan for payment after 90 days.
However, in order to fulfil those orders and supply the services that your clients demand your startup business needs to increase your monthly overheads. These overheads such as wages, taxes and rent have to be paid monthly whether you are banking your clients cheques or not.
As you can imagine this puts a huge strain on a young or growing business. In fact, cash flow problems are a reason many start ups fail in the first year of trading, as they just don’t have enough cash to keep themselves afloat when clients are late paying invoices.
The other challenge, is that late payment of invoices only becomes a problem when it is almost too late – as you will often be promised payment by ‘Friday’ only to discover that ‘Friday’ comes and goes too often. This can mean that your ability to raise money through a process – such as venture capital – which normally takes a few months to agree, isn’t fast enough.
This type of finance is termed “asset based” as what you receive is always based on the assets you have – and in this case, your invoices are treated as assets.
One of the quickest ways of overcoming this problem is to sell your invoices on to a third party – a practice known as invoice finance.
As soon as your issue an invoice, you’ll receive an agreed percentage immediately from the funder. The rest, minus a small admin fee, will come once your clients pay in full meaning that you get some of the money ‘up front’ so that you can meet your most immediate bills.
There are two types of invoice finance which can be split into
- Factoring and
- Invoice Discounting (here is an example of invoice discounting for businesses).
In this article I’m going to to focus on exactly what is meant by invoice discounting.
How is invoice discounting different from factoring
If you choose invoice discounting over factoring, this means that you will retain control over your sales ledger meaning that the job of ensuring your clients pay the invoices remains with you and your credit control team.
This means that your clients don’t need to know that you are using invoice discounting. It also helps you to work and build on your business relationships with your clients.
Factoring, on the other hand, puts the control of your sales ledger in the hands of the factoring company and they become responsible for collecting your invoices – which includes phoning and contacting your clients.
So, what are the advantages of invoice discounting?
Benefits of invoice finance
The key benefit of factoring and invoice finance is the the constant stream of cash flow you’re able to receive, as and when you issue invoices.
For many startup and fast growing businesses this is the boost they need to stabilise their cashflow as they look to grow and expand.
As the business starts to grow and more invoices are issued, the more funds will become available through invoice finance.
This method of funding your growth also rules out any need to borrow from traditional lenders such as the bank and accrue debt against your business at a critical time or take on the additional cost of servicing a loan. In addition, many businesses have recently discovered that when a bank chooses, it can renegotiate the loan on worse terms and may often require the entrepreneur to stake his or home as collateral.
As mention above, the benefit of invoice finance is that the invoices are treated as an asset and therefore no further (personal) collateral is required.
See here to find out more about the advantages of invoice discounting.