Invoice factoring works like this: you sell an unpaid business invoice to a company called a factor, receive an upfront advance of roughly 70% to 95% of the invoice’s face value within a day or two, and the factor then collects payment directly from your customer. Once your customer pays in full, the factor deducts its fee and releases the remaining balance to you. Because the transaction is a sale of an asset rather than a loan, it does not create debt on your balance sheet.
The appeal is speed. Instead of waiting 30, 60, or 90 days for a customer to pay, you get most of the money now. The cost is the factoring fee and a handful of smaller charges that vary by agreement.
What Invoices You Can Factor
Factoring is only available for invoices billed to other businesses or to government agencies. If you sell to individual consumers, this is not an option for you.
The invoice also has to represent work you have already finished or goods you have already delivered. You cannot factor an invoice for a job still in progress. Expect to hand over supporting documentation: purchase orders, signed delivery receipts, bills of lading, or approved timesheets. That paperwork proves the debt is real and unlikely to be disputed.
Factors care more about your customer’s ability to pay than about your own credit. Before buying your invoices, the factor evaluates each customer (the debtor) by looking at their payment history and financial stability. Many factors also cap how much of your factored portfolio can come from any single customer, often around 20%, so no one debtor represents more than a fifth of your outstanding receivables.
How Much You Get Upfront and What It Costs
The Advance Rate
The advance rate is the share of the invoice you receive immediately, typically 70% to 95%. Where you land depends on your industry, the creditworthiness of your customers, and how the factor rates the overall risk in your receivables. The rest sits in a reserve account until your customer pays.
The Factoring Fee
The factoring fee, sometimes called the discount rate, is what the factor charges to buy the invoice. Fees commonly run 1% to 5% of invoice value per month. Some factors charge a flat fee no matter how long payment takes; others use a tiered structure that grows the longer the invoice stays open. A common tier looks like 1% for the first 30 days and another 0.5% every 15 days after that. Slow-paying customers cost you more under this model, so ask exactly how the fee accrues before you sign.
The Fees That Get Added On
The headline rate is rarely the whole bill. Agreements often include:
- A one-time setup or due diligence fee for onboarding and legal paperwork.
- Credit check fees passed through each time the factor evaluates a new customer.
- Wire or ACH transfer fees on each advance and reserve release.
- Monthly service or administration fees for account maintenance and lockbox management.
- Monthly minimum fees if you fail to factor a set dollar volume of invoices.
- Misdirected payment fees when a customer pays you instead of the factor.
Ask for the full fee schedule in writing before you sign. The factoring fee alone will not tell you the true cost.
Recourse or Non-Recourse: Who Eats the Loss
One clause matters more than most: whether the agreement is recourse or non-recourse. It decides who absorbs the loss if a customer never pays.
Under recourse factoring, you stay on the hook. If the customer does not pay within the recourse window, often 60 to 120 days, you have to buy the invoice back or swap it for another eligible invoice. The factor can also pull the unpaid amount from your reserve or from future advances. Because the factor carries less risk, recourse fees are generally lower.
Under non-recourse factoring, the factor absorbs certain non-payment losses, but the protection is narrower than the label suggests. Most non-recourse agreements only cover specific events, such as the customer becoming insolvent or filing bankruptcy. If the customer refuses to pay because of a billing dispute or complaint about your work, that risk usually comes back to you. Non-recourse fees are higher to compensate the factor for the added exposure.
What Happens After You Submit an Invoice
Once the master agreement is in place, each factoring transaction follows the same cycle.
You send a batch of invoices, often called a schedule of accounts, through the factor’s portal or by email, along with the supporting documentation showing the work was done and accepted.
The factor then verifies each invoice, usually by contacting your customer’s accounts payable department to confirm the goods were received, the amount is right, and no disputes are pending. Verification protects both sides from fraud and billing errors. If a dispute surfaces, the factor will typically leave that invoice out of the funding until it is resolved.
After verification, the factor sends your advance by wire or ACH. Most factors fund within 24 to 48 hours of submission; some offer same-day funding for an added fee.
How Payment and Final Settlement Work
Collection is the factor’s job from here. Once your customer receives a valid notice of assignment, they can only discharge the debt by paying the factor. Paying you directly no longer counts.1Legal Information Institute. UCC 9-406 – Discharge of Account Debtor; Notification of Assignment
Your customer sends the full invoice payment to a lockbox or bank account controlled by the factor. The factor deducts the factoring fee and any other applicable charges from the reserve, then releases what is left, sometimes called the rebate, to you. A settlement report shows the total collected, the fees charged, and the amount paid out.
If your customer has a legitimate complaint about the underlying goods or services, the factor’s rights are limited. The factor stands in your shoes: the customer can raise the same defenses against the factor that they could have raised against you, as long as the claim arose before the customer received the assignment notice.2Legal Information Institute. UCC 9-404 – Rights Acquired by Assignee; Claims and Defenses Against Assignee A dispute over defective work can reduce what the factor collects and, in turn, what you receive from the reserve.
Contract Structure and Getting Out
Spot vs. Contract Factoring
Spot factoring lets you sell individual invoices as you choose, with no long-term commitment or monthly minimums. Flexibility is the benefit; the per-invoice fee is usually higher.
Contract factoring requires you to factor most of your invoices, or all invoices from certain customers, over a set term. Fees are typically lower and advance rates higher, but you are locked in, often with early termination penalties and monthly minimum volume requirements. If cash flow needs are steady and ongoing, contract factoring usually costs less overall. If you only need occasional help, spot factoring avoids the commitment.
Notification vs. Non-Notification
Most factoring agreements are notification arrangements: the factor sends your customer a formal notice of assignment directing payment to the factor. In non-notification factoring, your customers never learn a factor is involved and keep paying you as usual, with the funds forwarded on. Non-notification is generally reserved for established businesses with strong credit and comes with higher costs.
UCC Filings
To protect its interest in your receivables, the factor files a UCC-1 financing statement with the secretary of state. This public filing notifies other lenders that the factor has a claim on your accounts receivable and prevents you from pledging the same invoices as collateral elsewhere. A UCC-1 is legally required for most factoring arrangements to perfect the factor’s interest.3Legal Information Institute. UCC 9-309 – Security Interest Perfected Upon Attachment State filing fees are modest, generally $10 to $100, and the factor typically handles the paperwork but may pass the cost through.
Termination and Exit Fees
Ending a factoring relationship takes more than pausing submissions. Contract-based agreements usually require 30 to 90 days written notice. Leaving before the term ends triggers an early termination or buyout fee, calculated as a percentage of outstanding invoiced amounts, a flat charge, or both. A 2% buyout fee on $50,000 in open invoices would cost $1,000 to exit early. Some agreements also require you to repurchase every outstanding invoice not yet collected, so you need cash available to close out the pipeline.
Before signing, read the termination clause for automatic renewal provisions, the notice window, and the buyout formula. When the relationship ends, confirm the factor files a UCC-3 termination statement to clear the lien from public records; the fee is small, but the follow-through is on you.
Tax Treatment
Factoring fees — the discount rate, administration charges, and commissions — are generally deductible business expenses. Businesses either deduct them directly or net them against gross receipts.4Internal Revenue Service. Factoring of Receivables Audit Technique Guide Because factoring is a sale rather than a loan, the fees are not classified as interest expense. How you report them can affect your financial statements, so confirm the right approach with your accountant.