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Common sense doesn’t cost a penny yet can save you thousands of dollars’ worth of mistakes, time, and headaches. I never cease
to be amazed at how little common sense some new factors use when they start.
As with any investment, it only makes sense to begin very slowly and gradually increase your exposure as you learn what you’re
doing. In other words, don’t invest the bulk of your funds immediately or do so in only one or two invoices. Spoon feed yourself as you learn, slowly increasing the size of the bites as you take in the business and
digest it. This is the best way to limit your risk at the very beginning.
Let’s use two examples. Suppose a small factor named Steve has $15,000 in factoring funds and in a relatively short time he has two
clients. One factors about $6,000 per month, the other around $4,000, leaving Steve a cushion for their growth and unexpected cash needs. His rates are steadily earning at least $500 per month for his investment.
Now the $4,000 client routinely factors around 20 invoices each month that average $200 in size. One month she takes on a new customer but this customer immediately closes his doors right after the client
performs the service and invoices him. In short, this invoice goes bad and the customer never pays.
Steve’s chances are high that he will recoup this loss from other invoices this client has. If Steve’s on a
recourse basis, his client is obligated to make up this loss with a fresh invoice or deducting what he’s owed from reserves, rebates or future advances.
Even if Steve can’t recoup this particular bad debt, a
$200 loss is easily overcome by the $500 he is making monthly in fees – not to mention the reserves he’s steadily been putting aside from each fee earned. While this loss lowers his APR, it will have little if any
impact on his factoring business. Steve recovers from this small loss without missing a beat.
On the other hand, another small factor named Nick also has $15,000 to invest, but he ignores the most
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basic risk management tool. He has just started out and booked his first client who wants to factor a $19,000 invoice. Against
all common sense Nick invests all his funds in the only invoice of his single client’s first customer.
The worst case scenario happens: the customer never pays and the client can’t make up the money Nick’s
owed. He loses his $15,000 advance and has no more money to invest. He doesn’t even have money to pay a collection lawyer to try to recoup his loss. Nick turns away from factoring with his head down, shoulders
sagging, tail between his legs, and mutters that factoring is far too risky to be of any good to anybody. “Why did I ever do this in the first place, anyway?” he wonders.
Believe it or not, Nick’s scenario
plays out all too often. People are seduced by the high yields (which are attainable when managed properly), and big dollar signs spin in their eyeballs. The element of greed has taken its toll, overpowering the
wisdom of common sense and simple prudence.
Over-concentration – the mistake Nick made of having too much of his money in one client, customer, and/or invoice – is far and away the biggest reason factors
lose money and even go out of business, regardless of their size. I have seen small factors lose a few to several thousand dollars, and larger factors lose literally millions of dollars, from accounts in which they
were over-concentrated. In the great majority of cases when factors close their doors or merge with another factor, the primary cause can be traced to losses where the factors were over-concentrated.
When you act wisely and develop – and follow
– sound investment safeguards, you cannot have a catastrophic loss as Nick did. It’s only when you don’t develop, maintain, and follow these safeguards that your factoring investment comes into serious jeopardy.
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