Entrust Learning Center > 3. Investment Options > Using Factoring in Self-Directed IRAs and 401(k)s

Using Factoring in Self-Directed IRAs and 401(k)s

What is “factoring”?

Factoring is the discounted purchase of receivable invoices from corporations. The factor will purchase the receivable invoice and then collect directly from the client.

Factoring dates back to Roman times and derives from the Latin word “facere” which means “to do, to make, to get things done.” Roman factors worked for the Emperor. They collected taxes to finance day-to-day government, build roads, aqueducts and wage the occasional war.

The process worked something like this. The Emperor would post notices around town announcing a forthcoming auction of tax collection rights. The moneylenders would then bid for the right to collect these taxes. The highest bidder would be awarded the collection rights for which they paid a lump sum to the Emperor. It was then their job to go out and collect the taxes directly from the citizens. The Emperor discounted this income stream for cash, the taxes were ultimately collected and, more often than not, the factor made a profit. The free market system at work!

Today, factoring is used in the U.S., France, England and Italy.

How does factoring differ from a commercial bank lending money to a client and using receivables as collateral?

The factor actually purchases and owns the invoices. The client’s customer pays the factor directly, just as they would any other payable.

How does a factor make money?

This is an interesting process. Let’s use a $10,000 invoice with a “Class A Rated” client as an example.

Step 1: Background and credit analysis is done on the company’s client to determine the level of risk in repaying the invoice.

Step 2: 80% - $8000 is paid to the company.

Step 3: 20% - $2000 is kept in reserve to be refunded once the invoice is paid in full.

Step 4: The factor charges a flat fee for his service, say $350.00.

Step 5: A factor also charges a “% fee” for every 10, 14 or 30 days (you negotiate the terms) beyond the initial 30 days allowed, that the invoice remains unpaid.

The flat fee and “%” fees are deducted from the 20% reserve.

This is not a loan. Who is at risk if the invoice remains uncollected?

Once the reserve is “drained” other collateral is used. It’s rare, but occasionally it does happen.

Doesn’t a bank loan make more sense?

Banks often have restrictions related to cash flow, ratios, profitability, etc. Financing is refused for many reasons, including poor financial history. In fact, we get referrals from banks who cannot meet a client’s financial needs but do not want to lose that client to another bank.

How do factoring professionals differ from other lenders?

Factoring professionals are not in the “lending” business. A decision to purchase Accounts Receivable invoices are influenced by the quality of the customer base and performance—NOT by the number of years in business or financial strength.

How do you remain successful?

Extensive up front credit analysis of not only the client from whom we are purchasing invoices, but especially of their customer who owes the money.

How can I use my IRA/401(k) funds to invest in factoring?

You might choose to become a factor directly; however the backroom, credit access and administration can be a nightmare. Avoiding fraud and default are ongoing concerns.
Instead, an IRA investor might choose to invest in a well-run, professional factor or factoring company. Factors look for interim capital for their short term financing. That can be done with a private pool of capital, participation notes or any number of combinations of the two.

The answers to these questions were provided by Thomas Stamborski, President of Liquid Capital of Illinois.

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