March 31, 2023
As a truck driver, your primary focus is to move freight safely and on time. However, as you know very well, there is much more to running a trucking company than simply picking up and delivering a load. You have insurance to select, equipment to maintain, bills to pay, and maybe even staff to manage – all of which require access to consistent cash flow. As you explore financing options for your trucking business, you may come across two popular choices: freight factoring and business loans. Both can help you access the funds you need to grow your business, but which one is right for you? In this blog post, we’ll define freight factoring and business loans, weigh their pros and cons, and provide guidance to decide which option is best suited for your trucking business.
What is Freight Factoring?
If you want a full explanation of freight factoring, we made an entire blog post about it here. But to keep it brief, freight factoring – sometimes known as invoice factoring or trucking factoring – is where a factoring company pays your invoice for hauling a load within 24 hours (minus a small fee for their services), then bills your customer and takes on the waiting period to get paid in 30, 60, or 90 days. This gives you access to immediate cash to keep your business running smoothly, while also saving you time by taking back-office and collections work off your plate.
Types of Freight Factoring
There are two types of factoring arrangements: recourse and non-recourse.
Recourse Factoring: The most common form of factoring where a factoring company purchases your outstanding invoices and provides you with the funds upfront, less a fee for their services. However, if the customer fails to pay the invoice, the responsibility for paying the factoring company reverts to you. In other words, you are responsible for repaying the advance if your customer doesn’t pay the invoice.
- Pros: Easy to obtain, lower fees, immediate access to capital, no debt, your credit score doesn’t matter.
- Cons: Liability to repay uncollectable invoices
Non-Recourse Factoring: Non-recourse factoring, on the other hand, is a financing option in which the factoring company assumes the credit risk of your customer. This means that if your customer fails to pay the invoice due to insolvency or other factors, the factoring company assumes responsibility for the payment, and you are not required to repay the advance. Non-recourse factoring is typically slightly more expensive than recourse factoring due to the higher credit risk assumed by the factoring company.
- Pros: Zero risk, immediate access to capital, no debt, your credit score doesn’t matter.
- Cons: Higher fees, more difficult to qualify.
What is a Business Loan?
A business loan is a type of commercial financing that a qualified business can get from a bank, credit union, savings and loan association, or an online lender. They provide business owners with financing either as a lump sum of money or a credit line. In exchange for the borrowed money, your business agrees to repay the loan over time, plus interest and fees.
Prior to the pandemic, 80% of businesses that applied for loans received at least partial approval, according to Forbes.com. But in 2020, that number fell to 76%. In general, business owners can apply for loans of up to $5 million. However, the amount of money you can receive depends on how risky the lender believes you to be based on several factors: your personal credit score, your business credit score, annual revenue, existing debts, the length of time you’ve been in business, and your experience in your industry all play a role in determining how much money you can qualify for.
There are many different types of business loans, and each can be used for different purposes. Here is a brief overview of each.
Types of Business Loans
Business Term Loan: A lump sum of capital provided by a lender, which is paid back over a set period of time with interest and fees.
- Pros: Large amount of capital, predictable payments, potential tax benefits.
- Cons: Collateral requirements, lengthy approval process, interest rates, and fees.
Business Line of Credit: A flexible financing option that provides access to a revolving credit line that can be drawn upon as needed.
- Pros: Flexibility, lower costs, credit building.
- Cons: Limited credit, higher interest rates for riskier borrowers, and potential for overspending.
SBA Loan: A government-guaranteed loan provided by the Small Business Administration to help small businesses access financing.
- Pros: Lower interest rates, longer repayment terms, and access to capital.
- Cons: Lengthy application process, strict eligibility requirements, personal guarantee requirements.
Short-Term Business Loan: A type of financing that provides a lump sum of capital to be repaid over a shorter period, usually up to 18 months.
- Pros: Quick access to capital, flexibility.
- Cons: Higher interest rates and fees, short repayment terms, collateral requirements.
Equipment Loan: A type of loan used to purchase new or used equipment for a business, with the equipment itself serving as collateral.
- Pros: Lower rates, tax benefits.
- Cons: Depreciation, collateral requirements, limited use.
Merchant Cash Advance: A type of financing where a lender advances a lump sum of cash to a business in exchange for a portion of the business’s future accounts receivable.
- Pros: Quick access to capital, flexible repayment, no collateral required.
- Cons: High costs, daily repayments, cannot be used in conjunction with freight factoring.
Personal Loan for Business: A type of financing that allows business owners to use their personal credit and income to obtain a loan for their business.
- Pros: Easier to obtain, no collateral required, flexible use of funds.
- Cons: Limited borrowing capacity, higher interest rates, personal liability.
Microloan Loan: A small loan typically offered by non-profit organizations, community development financial institutions, or government agencies to help start or grow a small business.
- Pros: Accessible to underserved borrowers, personalized support.
- Cons: Higher interest rates, limited funding, limited availability.
Commercial Real Estate Loan: A type of financing used to purchase, refinance, or develop commercial properties, such as office buildings, retail spaces, and industrial facilities.
- Pros: Long repayment terms, lower interest rates, investment opportunity.
- Cons: High down payment requirement, property risk, lengthy approval process.
Business Credit Card: A revolving line of credit that allows businesses to make purchases and pay off the balance over time.
- Pros: Convenient access to credit, rewards and benefits, helps build credit.
- Cons: High-interest rates, risk of overspending, potential for personal liability.
What to Consider When Choosing Between Freight Factoring and a Business Loan
It’s important to note that freight factoring and business loans are often used for different reasons, so comparing the two is not an apples-to-apples comparison. It would be helpful to do an audit of your circumstances and evaluate what it is you are really looking for in a financing partner. Here are some things to ask yourself:
- Am I trying to start or grow my business?
- Do I want to improve my cash flow?
- Am I looking to invest in a long-term opportunity?
- Does my business have a good or bad credit history? Do I need to establish/build credit?
- Does my business struggle with back-office duties like bookkeeping, collections, and paperwork?
- Am I able to afford a monthly loan repayment plan?
- Do my customers struggle to pay me on time, or are they very prompt?
- Are my customers financially healthy businesses?
- What is the volume/frequency of my invoices? Do I send invoices out daily, weekly, monthly?
- Are my invoices usually a high dollar amount?
Here is a helpful comparison chart:
Advantages of Freight Factoring Over a Business Loan
One advantage of freight factoring over a business loan is the fee schedule. In general, the freight factoring fee is a substantially lower percentage than you would find with a business loan, a line of credit, or a merchant cash advance. Freight factoring also allows for more room to negotiate your fees than you would find with a typical lending institution. By choosing which invoices to factor, how frequently you factor, and negotiating other variables, you end up with a highly customized financial solution that can flex with your business as market cycles and seasonality impact you.
Another significant advantage is that freight factoring offers more flexibility than a business loan. Loans are often accompanied by restrictive covenants. These covenants are designed to protect the lender by imposing strict terms of compliance on the borrower, such as requiring you to maintain certain financial ratios or limiting how you can use the borrowed money. If these covenants are broken, the borrower is often heavily penalized. Since freight factoring is not a debt, there are no covenants, and you can choose to do whatever you want with your money.
One thing to note is that there are many factoring companies that also impose contracts with restrictive terms. It’s important to thoroughly read your contract before signing it to ensure you understand the terms, which usually include minimum invoice requirements and heavy termination fees. One of the main benefits of choosing to do business with a factoring company that does not require contracts is the flexibility it provides. This allows trucking companies to use factoring services on an as-needed basis, without being locked into a long-term agreement. Additionally, this flexibility allows businesses to switch to another factoring company if they find a better deal or stop factoring altogether if their financial situation changes.
Can You Use Freight Factoring and Also Have a Business Loan?
Yes, it is possible to qualify for freight factoring even if you have a business loan. In fact, many trucking companies use both business loans and freight factoring services to meet their financial needs.
A trucking company might use a business loan to finance larger, long-term investments such as purchasing new equipment or expanding their business. Business loans typically offer lower interest rates and longer repayment terms, making them a more cost-effective option for larger, long-term investments.
On the other hand, a trucking company might use freight factoring services to improve their cash flow and cover short-term expenses such as fuel and payroll. Freight factoring services offer quick access to cash and do not require collateral or a credit check, making them a good option for companies with poor credit or limited assets. The increased cash flow also enables trucking companies to take advantage of opportunities that they would have otherwise missed out on due to a lack of immediate cash. This is also known as an “opportunity cost.”
By using both business loans and freight factoring services, a trucking company can take advantage of the benefits of both options and ensure that they have the funding they need to meet their financial obligations and achieve their long-term goals.
Freight Factoring and Business Loans are Both Helpful Financial Tools with Unique Differences
The world of financing is big and often intimidating, but it doesn’t have to be complex. Each financial tool is really a simple service at its core, designed to help businesses and create a win-win situation. While freight factoring and a business loan are two completely different things, they can each play a role in your financial strategy.
If freight factoring sounds like an option that makes sense for your trucking business, the experts at OpenRoad Financial Services are available to help you get the process started, or simply answer any additional questions you have.