Documentation 101 for Factoring Transactions

by Peter Pirri

The four essential documents needed to review and understand a possible accounts receivable factoring transaction are (1) an Application (2) Accounts Receivable Aging Report (3) Sample Invoice (4) Articles of Organization. The aforementioned are essential but not required in all cases. However, the more information that is documented in the beginning, the easier it becomes later on to close a transaction.

The Application

A properly completed application, signed by the client, indicates intention. In any business deal or contract there must be a sense of intention. A client’s willingness to factor can be identified in the way an application is filled out. If items or questions are left blank or a signature is not obtained, the factor may not consider the level of intention or interest expressed by the client to be significant.

In addition, the application should always indicate the type of business the client is involved in, information that provides the factor with an idea of the amount of risk involved in the transaction and what documents would be required to fully understand the products and services the client is offering its customers. As a broker, you are also presenting the deal to the factor to procure the best rates possible for the client.

Accounts Receivable Aging Report

A current accounts receivable aging report is a critical document. It provides valuable information and identifies whom the client is selling to, how much is owed, and how quickly the receivables are paid. The accounts receivable aging report should be sorted by date and customer. Other reports such as “open invoice detail” and “trial balances” are not as informative. A factor or funding company wants to see what is available for purchase immediately. The accounts receivable aging report can also identify problems such are collection issues, bad debt, retainage, and deposits that are not apparent on the invoices.

Sample Invoice

A sample invoice provided to the factor for due diligence should be an invoice that the client has previously sent to a customer that they would like considered for a factoring relationship. The invoice will display the trade name, the terms of payment, the account debtor, the party in receipt of the merchandise, and delivery details. When funding sources purchase invoices, they “step into the shoes of the client,” and they want to be sure that their titles to the invoices are unencumbered and their rights to receive payments in a timely fashion can be effectively enforced. It is not helpful to the funding sources if clients submit “blank” invoices to be reviewed.

The Articles of Organization

The Articles of Organization identify the legal entity that owns the invoices and the state in which they are filed. Also, it identifies the owners or managing members. This information is very important when it comes time to file the appropriate UCC Financing Statement. From a legal perspective, it’s important to remember that corporations or limited liability companies own all rights, title, and interests in the accounts receivable and individuals own the corporation or company. If a UCC Financing Statement is not filed with the appropriate state agency, including the correct organizational identification number, the financing statement may be rejected, and the funding source will not have a first security interest in all the accounts receivable for several more days or weeks until it is fully corrected.

Once the client enters into a contract with the factor and invoices are assigned or sold to the funding source for factoring by the client’s authorized representative, additional documents may be required: purchase orders, confirmation of delivery, and any type of contract or agreement between the account debtor and client. One may inquire, “Why are these things important? The invoices are the only documents with a quantifiable value.” The reason for the increased vigilance in the factoring business is the risk of a client generating a fraudulent invoice or an invoice that is not an accurate reflection of the agreement with the account debtor. The funding source must become comfortable with the transaction and be sure that goods and services were properly delivered and that payment will be made in a timely fashion, usually within 90 days of the invoice date.

To restate, invoices must represent goods and services that have been delivered. Invoices that represent partial shipments or agreements for future service are not acceptable for factoring because this dramatically reduces the account debtor’s willingness to pay. Why would anyone pay for something he hasn’t received? As a consumer, you wouldn’t pay for jeans at Target and then pick them up the next day! Funding sources must feel comfortable that the invoice represents a final sale.