Lines of credit, factoring and the cash advance trap

A bank approves a limit. You draw what you need, pay interest only on what you've drawn, and draw again after you repay.

The house rule: draw only against signed, billed work, and pay the line back to zero every year from collections. Ask the bank whether it requires a yearly pay-down period and when, because a spring pay-down can land in your busiest buying month.

Example (made-up numbers). Lena's company finishes a $30,000 HOA parking lot in June. The HOA pays in 45 days, but payroll and the sealer bill are due now. She draws $20,000 against that signed, billed invoice and pays it back the day the HOA pays. At an example 10% rate, 45 days costs about $250.

If you're drawing on the line in February with nothing billed, it isn't covering timing anymore. Slow-season costs come from the winter reserve, not the bank.

A factoring company buys a commercial invoice for less than its face value and collects from your customer. The discount is your cost.

Yearly rate = fee ÷ cash you received × 365 ÷ days until the customer pays.

Example (made-up numbers). You sell a $10,000 invoice for $9,700, and the customer pays the factor in 30 days. $300 ÷ $9,700 = 3.1% for 30 days, or about 38% a year.

• Commercial work only. Factoring fits invoices to businesses, property managers and HOAs on payment terms. Homeowners usually pay at completion.
• Recourse or non-recourse. With recourse, you buy the invoice back if the customer doesn't pay. Non-recourse moves some of that risk to the factor, usually for a higher fee. Read exactly which nonpayments it covers.
• Read the contract. Look for minimum volumes, the length and how to cancel, fees that grow the longer your customer takes, how the factor contacts your customers, and any lien on all your receivables.

You don't need one; a debit card on the business account works. If you use one, pay the full balance every month and never take a cash advance. If you can't pay a statement in full, stop using the card and treat that as a cash warning (B102.1).

A cash advance company gives you a lump sum now in exchange for a share of your future sales. You repay the amount times a "factor rate," usually through daily or weekly debits from your bank account.

A factor rate is not an interest rate. It applies to the whole amount at the start and doesn't fall as you pay it down.

Example (made-up numbers, approximate). A $20,000 advance at a factor rate of 1.30 means you repay $26,000 at $1,000 a week for 26 weeks. The 1.30 sounds like 30%. But you repay it in six months, a little every week, so on average you have only about half the money. As an APR, that's about 107%. To check any offer, a spreadsheet does the math: =RATE(26,-1000,20000)*52. A fee taken off the top pushes it higher.

In 2021, Yellowstone Capital agreed to pay more than $9.8 million to settle FTC charges that it misstated funding amounts and kept withdrawing money after advances were paid off. Kansas and Missouri require many non-bank providers to disclose the total of payments, the total dollar cost and any prepayment terms on business financing of $0.5 million or less. The disclosure doesn't have to show an APR.

Never take a merchant cash advance or any other daily-debit financing, under any rate.

• Small Business Development Centers: free help comparing financing offers (find your SBDC).
• SCORE: free mentoring (score.org).