What is invoice factoring and how does it work?

Small businesses need help with cash flow

Two out of five American small businesses struggle with cash flow, according to Intuit.

For these businesses, the stakes couldn’t be higher. In fact, half of all small businesses fail within their first five years—many because they fail to manage the timing of income and expenses.

Fortunately, if you are a platform that has visibility into your customers’ invoices, you’re in a great position to help your customers smooth uneven cash flow.

In many industries, it’s common to wait 30–90 days to get paid. But when businesses factor their invoices, they can access those funds right away. By providing invoice factoring to your customers, you can increase average revenue per user and stand out from the competition, driving acquisition and retention. 

“Invoice factoring can be especially valuable for businesses that struggle to access credit,” says Chuck Stoops, General Counsel at Tradeshift. “It’s a cost-effective way for them to get the funds they need—and might not be able to get, otherwise.”

If you’re a leader at a tech company that serves businesses, this guide is for you. In it, we’ll cover:

• How invoice factoring works
• How invoice factoring generates revenue
• What invoice factoring could look like on your platform
• How to launch an invoice factoring program in weeks

How does invoice factoring work?

Invoice factoring is a type of embedded financing in which your customers receive funds right away by selling you the right to collect payment on an invoice.

It’s a good fit for platforms that have visibility into or help manage their customers’ invoices, orders, and future payments. Examples include Supply Chain and Logistics (e.g., OTR Solutions), Professional Services (e.g., Invoice2go) and Construction Management (e.g., Procore).

To show how invoice factoring works, let’s say you’re the VP of Product at Alcove, a platform that connects general contractors with businesses seeking construction services. 

1. One of your customers, Troy’s Construction, signs a contract to complete an office remodel for a business in Los Angeles.

2. Upon completing the project, your customer sends the business an invoice for $10,000. The business has 30 days to pay it.

3. Your customer decides to factor the invoice. They tap a button in your app.

4. You send $9,500 to your customer, which they can immediately access in their bank account.

5. At the end of the month, the business pays the $10,000 invoice.

6. You receive the business’s $10,000 payment, recouping the $9,500 you sent to your customer and netting $500 in revenue.

Why would my customers want this from me?

While it’s possible for your customers to use an external provider to factor their invoices, there are key advantages to doing it through your platform:

• Instant access to funds. When your customers work with traditional invoice factoring providers, it can take weeks for them to get approved and access factored funds in their bank accounts. By contrast, when they factor with you, they can start spending their money instantly.

• A frictionless experience. Your customers’ invoices are repaid automatically, which means you and your customers don’t have to do any additional administrative work. 

• Better factoring rates. You have unique insight into your customers’ business model and can underwrite them more effectively than a traditional invoice factoring provider could. After your customer’s invoice is repaid, the funds are automatically deposited in your operational account, which lowers the risk of nonpayment. Because of the lower risk of working with you, you can offer better rates—potentially saving your customers thousands of dollars per year.

• A one-stop shop. Since your platform already has your customers’ company and invoice data, you can pre-qualify them for financing—making it simple for them to apply. As a result, they can access financing without needing to start a relationship with another company or financial institution.

How invoice factoring benefits your business

Invoice factoring isn’t just valuable for your customers—it can also boost your business. With invoice factoring, you can:

• Generate more revenue per user. Platforms that offer invoice factoring typically charge their customers 1-3% of the total value of each factored invoice. In some cases, the resulting revenue can lead to a 50% increase in average revenue per user (ARPU).

• Drive acquisition and retention. Because invoice factoring helps to solve your customers’ cash-flow problems, it can set you apart from your competitors. That, in turn, can help drive customers to your platform and make it stickier. For example, Roofstock has discovered that customers who use their Stessa Cash Management accounts are retained at a rate 3.5x higher than other users.

• Offer additional financial products. After launching invoice factoring, you may consider adding other financial products—things like bank accounts, debit cards, and charge cards. In this way, you can deliver more value to your customers while also generating robust new revenue streams. For example, Nav found that customers who use banking or lending products are 2.5x more likely to purchase other products on their platform.

To demonstrate how invoice factoring can lead to a 50% increase in average revenue per user (ARPU), let’s return to our example. Remember, you’re the VP of Product at Alcove, a platform that connects general contractors with businesses seeking construction services.

Let’s assume you charge your customers (e.g., Troy’s Construction) $50 per month for access to your platform. Let’s assume your average customer sends $10K worth of invoices per month. If you’re able to factor 25% of those invoices ($2.5K per month, per customer) and take 1% as revenue ($25), then you’ve achieved a 50% increase in average revenue per user (ARPU).

How Unit can help

Unit is a financial infrastructure platform. That means we help tech companies offer embedded bank accounts, cards, lending, and money movement to their customers. 

Platforms like yours choose to launch invoice factoring with us because it’s low-friction and fast. If you’re ready to launch invoice factoring, we can help with the following:

• Underwriting. Underwriting means deciding whether and how much to lend to your customers. For many tech companies, it can be daunting. Fortunately, Unit facilitates this part of the process, so you don’t have to worry about it. 

• Capital. Unit provides access to capital to support your invoice factoring program, so there’s no need to pull those funds from your company’s balance sheet.

• Bank partner. We’ll connect you with the right bank(s) and help manage the partnership. This reduces the time you’ll need to invest.

• Compliance. We streamline processes like KYC, transaction monitoring, and manual account reviews. Our compliance program, led by compliance and risk veterans, handles the majority of compliance so you don’t have to. 

• Technology. We provide all of the necessary financial infrastructure to build a fully functional banking product. With our suite of white-label user interfaces, you can launch with just a few lines of code.

Interested in learning more about how invoice factoring could work for your company? Start a conversation with us; you can also check out our sandbox and build in minutes.