You finally landed the customer you needed to get your startup off the ground. There’s just one problem: you can’t afford to do the work.
The customer wants 30, 60, or even 90 days to pay. Your employees need to be paid this Friday. Your suppliers want their money now. And your customer probably isn’t interested in hearing that your startup is waiting for another customer to pay an invoice.
Welcome to one of the biggest challenges facing startup businesses: cash flow.
Many entrepreneurs assume that once they start generating sales, their biggest problem will be finding more customers. Sometimes, it’s actually finding enough working capital to fulfill the orders they’ve already won.
So how can a startup get working capital when a traditional bank won’t lend to it? The answer may be closer than you think: your accounts receivable may be one of your startup’s most valuable financing assets.
Why Startups Have Trouble Getting Traditional Financing
Banks generally like predictable businesses. Startups are often anything but predictable.
Even if your business has strong customers and growing sales, you may have difficulty qualifying for a traditional bank loan or line of credit because your company may have:
- Limited operating history
- Little or no borrowing history
- Limited business credit
- Uneven financial results
- Limited assets to use as collateral
- A short track record of profitability
- Significant growth requiring additional capital
This doesn’t necessarily mean your business is a bad credit risk. It may simply mean that your business doesn’t fit the bank’s traditional lending model yet.
That’s an important distinction. A startup can have an excellent business model, strong customers, and significant growth potential while still having difficulty obtaining conventional financing.
The Startup Cash-Flow Trap
Here’s a common scenario. You launch a staffing company and win a contract worth $100,000 per month. That’s fantastic. But now you need to hire employees and pay them every week or two, while your customer pays invoices in 45 days. Your company could generate substantial revenue while simultaneously experiencing a cash shortage.
The same thing can happen to a manufacturer who receives a large order and needs to purchase raw materials before the product can be built. Or a distributor that needs to purchase inventory before shipping it to a customer. Or an oilfield service company that has to pay employees, fuel suppliers, and subcontractors before receiving payment from its customer.
In each case, growth requires cash before the revenue becomes cash. That’s the startup cash-flow trap.
Revenue Isn’t the Same as Cash
This is one of the most important financial concepts for a new business owner to understand.
Suppose your startup invoices customers $150,000 this month. You might say:
“We did $150,000 in business.”
That’s true. But you didn’t necessarily receive $150,000. If your customers have 60-day payment terms, much of that money may still be sitting in accounts receivable. Your income statement may look encouraging while your bank account tells a completely different story.
This is why startup owners need to understand the difference between revenue and cash flow. Revenue measures what you’ve earned. Cash flow measures the money actually moving into and out of your business. A company can be profitable and still run out of cash.
What Is Invoice Factoring?
Invoice factoring can provide a solution for startups that sell to other businesses and issue invoices with payment terms. Instead of waiting weeks or months for customers to pay, a factoring company purchases or advances against eligible invoices.
For example, suppose your startup completes $50,000 of work for a customer and sends a $50,000 invoice. Rather than waiting 60 days for payment, your business may be able to receive a substantial percentage of the invoice value shortly after the invoice is verified and approved. When your customer pays the invoice, the remaining balance — less the applicable factoring fees — is generally released to your company.
The result? An invoice that might have taken 60 days to turn into cash can become working capital much sooner.
Why Factoring Can Make Sense for a Startup
The biggest advantage for many startups is that invoice factoring focuses heavily on the creditworthiness of the customers who owe the invoices. That can make factoring fundamentally different from traditional business lending.
Imagine you’ve been in business for nine months. Your company is growing rapidly, you have excellent commercial customers, and your invoices are being paid reliably. But the bank tells you that you haven’t been in business long enough to qualify for the financing you need.
That’s frustrating. But if your customers are financially strong and your invoices meet the factoring company’s requirements, your receivables may still provide a potential source of working capital. In other words, your startup’s youth doesn’t necessarily eliminate the value of your accounts receivable.
What Can a Startup Use Factoring Money For?
Working capital is flexible, which is particularly important during the early stages of a company. A startup may use available cash to:
Fund payroll
For many startups, payroll is the largest recurring expense. If customers pay slowly but employees must be paid regularly, factoring can help bridge that timing difference.
Purchase inventory
If you have a large customer order, you may need inventory before you receive payment for the finished product. Access to working capital can help you accept opportunities that otherwise might be out of reach.
Pay suppliers
Maintaining good relationships with vendors can be critical for a young business. Having the cash to pay suppliers on time can help you keep favorable relationships and potentially negotiate better terms as your company grows.
Hire employees
Growth frequently requires additional employees, but hiring ahead of revenue can put tremendous pressure on a startup’s cash reserves. Working capital can help support expansion.
Accept larger customers
Sometimes the biggest opportunity is also the biggest financial challenge. A large customer may represent a significant increase in revenue but also require your company to carry substantially more accounts receivable. Factoring can potentially provide financing that grows as your receivables grow.
What Does a Factoring Company Look For?
Every factoring company has its own underwriting standards, but startups should understand one important concept: the quality of your customers matters.
A factoring company will typically want to know:
- Who are your customers?
- How financially strong are they?
- How long do they typically take to pay?
- Are the invoices legitimate?
- Are there disputes or chargebacks?
- What are your payment terms?
- How much are your outstanding receivables?
- What industry does your company operate in?
This means a startup with strong commercial customers may be more financeable than its short operating history would suggest.
Factoring Isn’t Free — So Look at the Bigger Picture
Invoice factoring has a cost, and responsible business owners should understand that cost before entering into an agreement. But don’t evaluate financing solely by asking, “What is the fee?” Also ask, “What will this capital allow my company to accomplish?”
Suppose obtaining working capital allows your startup to accept a $250,000 customer contract that generates a healthy profit. The financing cost is only one part of the equation. The more important question becomes whether the additional revenue and profit created by having access to capital outweigh the financing expense. That’s how successful business owners evaluate financial decisions.
Don’t Give Away Equity Just to Solve a Cash-Flow Problem
Another option some startups consider is raising money from investors. Equity financing can make sense in the right circumstances, but it also means giving up some ownership of your company. If your primary problem is simply the timing of customer payments, selling an ownership interest may be an unnecessarily expensive solution.
If you already have customers and invoices, you may have another option. Instead of selling part of your company, you may be able to leverage the receivables your company has already generated.
Build Your Startup Around Cash Flow — Not Just Sales
One of the smartest things a startup owner can do is begin thinking about cash flow before it becomes a crisis. Before accepting a major customer, ask yourself three questions:
- How long will it take me to get paid?
- How much will it cost me to deliver the work before I get paid?
- Where will that working capital come from?
Those three questions can prevent a surprising number of startup cash-flow problems. The goal isn’t to avoid growth — it’s to make sure your company’s cash flow can support it.
The Bottom Line for Startup Owners
Starting a business is difficult. Growing one can be even harder.
You may have customers. You may have profitable contracts. You may have an excellent product or service. But if customers pay you 30, 60, or 90 days after you complete the work, your business needs a way to bridge that gap.
Traditional bank financing may eventually become an excellent option, but you don’t necessarily have to wait years before exploring working-capital solutions. Invoice factoring can give qualifying startups a way to turn accounts receivable into working capital sooner, potentially allowing them to fund payroll, purchase inventory, pay suppliers, hire employees, and pursue new business opportunities.
At American Receivable, we’ve been helping businesses access working capital through invoice factoring since 1979. We work with companies across a variety of industries and understand that startups often need financing that reflects where their business is going — not simply where it has been.
If your startup has good commercial customers but is struggling with the gap between doing the work and getting paid, don’t automatically assume you have a financing problem. You may simply have a cash-flow timing problem — and your accounts receivable may be the solution.
