As with any financing relationship, make it a priority to understand your exit strategy options with your factoring company. Before you enter into the relationship, ensure you know the steps to take and associated penalties in case you need to break the contract.
Switching your financing partner to another factoring company may be beneficial in situations including:
• Better pricing found elsewhere
• Unsatisfactory level of service with current funding partner
• Desire to switch to a partner with expertise in your industry
In the event of an early termination, several factors you’ll need to be aware of include: length of agreement, auto-renewals, window for notification, early termination fees and other penalties associated with terminating.
Length of Agreement with a Factoring Company
A one (1) year term is the most common length of an invoice factoring agreement. However, terms lasting as long as two and three years exist with some factoring companies. A shorter term equates to more flexibility. For optimal flexibility, don’t agree to terms longer than one year.
Auto-renewal and Window for Notification
The length of agreement (term) also becomes a factor with the auto-renewal clause. Most factoring agreements automatically renew for another subsequent term without termination notice. For example, if your two-year contract expires in June of 2017 and you miss the window for notification, you are automatically locked in for another two years or until at least June of 2019.
Know your auto-renewal date (typically the date the contract was signed). More importantly, know the window for notification. Two to three months is the most common window for notification, but longer lead times do exist. Mark the notification date on your calendar and have a conversation with your factoring company. By not giving notice, you will automatically be locked in for another term and will not have an opportunity to reevaluate your position and negotiate a better deal.
Early Termination Fees by Factoring Companies
Setting up the relationship requires time and resources by the factoring company at the onset, so it typically takes the contract term to recover those costs. Factoring companies ensure they cover these costs by imposing early termination fees.
A simple and common early termination fee is calculated as (monthly minimum fee X the number of months remaining in the term). Look for these variables to be outlined in your invoice factoring agreement. Another calculation could be (monthly minimum volume X a pre-determined percentage). Crunch the numbers before signing your agreement to understand what an early termination would cost.
To recap, when you sign an agreement with a factoring company:
1. Remember a shorter term is best, don’t sign multi-year agreements
2. Know your notification date and set up a calendar reminder to review the agreement each year
3. Understand how much it would cost to exit your agreement early in case you find yourself wanting to go with another partner