In the world of business acquisitions, the ability to manage cash flow efficiently is crucial. Acquiring a company often involves significant financial transactions, and finding ways to optimise your cash flow can make a substantial difference in the overall success of the deal. Invoicing discounting, also known as invoice factoring, is a financial tool that can play a pivotal role in facilitating acquisitions. However, it’s essential to understand the true costs associated with this method. In this blog, we’ll explore the concept of invoicing discounting for acquisitions and discuss how to determine its true cost.

Understanding Invoicing Discounting

Invoicing discounting, or invoice factoring, is a financial solution where a business sells its outstanding invoices to a third-party company, often referred to as a factor or a invoice discounting company. The factor then advances a certain percentage of the invoice amount (usually around 80-90%) to the business, providing immediate access to much-needed capital. In factoring arrangments, the factor also assumes responsibility for collecting payment from the customer, whereas invoice discounting, the responsibility for collecting payments remains with the SME. Once the customer pays the invoice, the factor deducts its fees and the remaining balance is available for drawdown to the business.

For companies looking to finance an acquisition, invoicing discounting can be an attractive option. It provides an injection of working capital without giving away equity. This can be especially advantageous if the acquisition target is experiencing cash flow issues, as it allows the acquirer to secure the deal and address any immediate financial concerns.

However, as with any financial arrangement, there are costs involved. To determine the true cost of invoicing discounting for acquisitions, it’s crucial to consider several key factors.

Factor/Invoicing Discounting Fees and Discount Rates

The primary cost associated with invoicing discounting is the lenders fees and discount rates. These fees typically include two components: a service fee and the discount fee.

1. Service Fee: The service fee is a percentage of the total invoice amount, and it covers the administrative costs incurred by the factor for processing the invoice and managing the collection process. Service fees can range from 0.15% to 5% of the total invoices going through the facility, depending on turnover of the business, and can be subject to minimum monthly fees.
2. Discount Fee: The discount fee, also known as the discount rate or factor rate, represents the cost of capital advanced by the factor and is in addition to the base rate used by the lender, which can be Bank of England base rate, LIBOR rate or the lender’s own rate. This fee, being an annualised rate, is calculated on a pro-rata basis on the funding going through the facility. Discount rates can vary significantly, typically ranging from 1% to 5% per annum on top of the relevant base rate.

To determine the total cost of invoicing discounting for an acquisition, you’ll need to factor in both the service fee and the discount fee. Be aware that additional costs may apply if invoices remain outstanding for an extended period.

Invoice Volume and Frequency

Another critical factor to consider when calculating the true cost of invoicing discounting for acquisitions is the volume and frequency of your invoices. The more invoices you factor, and the more often you do it, the lower the percentage costs will be. This is because you’ll be paying service fees and discount fees across a larger turnover, particularly true as more acquisitions are bolted on.

However, for businesses, this cost may be outweighed by the benefits of accessing cash flow during an acquisition. By factoring invoices, you can ensure that you have the necessary funds to complete the deal and integrate the acquired company smoothly.

It’s essential to analyse the target company’s historical invoice data and project future needs to estimate the impact of these costs accurately. If you anticipate a high volume of invoices during the acquisition period and further into the future, you might be able to negotiate better terms with the factor.

Invoice Payment Terms

The payment terms on your invoices can also affect the overall cost of factoring for acquisitions. If your customers typically pay their invoices quickly, the cost of factoring may be lower. However, if your payment terms are more extended, you’ll incur higher discount fees.

To mitigate these costs, consider negotiating shorter payment terms with your customers or implementing an efficient accounts receivable management process. The faster your customers pay their invoices, the less you’ll pay in discount fees, reducing the overall cost of factoring.

Factor Reputation and Agreements

Choosing the right factor or invoice discounter is critical when factoring invoices for acquisitions. Not all factors are created equal, and the terms and conditions vary significantly between providers. A well-established, reputable factor may charge lower fees, and their services could be more reliable.

Before entering into an agreement with a factor or invoice discounter, carefully review the contract and terms and conditions. Consider any additional costs or penalties that may apply, such as concentration limits, refactoring fees or minimum service fees. Also, inquire about their customer service quality, as these factors can significantly impact your acquisition process.

Opportunity Costs

While it’s essential to consider the direct costs associated with invoicing discounting, don’t forget to account for opportunity costs. By choosing to factor your invoices, you are essentially trading a portion of your revenue for immediate cash. This can limit your ability to invest in other opportunities or initiatives.

Consider the potential returns you could achieve if you had access to your full invoice amounts and the effects of factoring on your long-term financial health. The decision to factor invoices should align with your acquisition strategy and broader financial goals.

Evaluating the Trade-Off

Determining the true cost of invoicing discounting for acquisitions is not solely about calculating the direct costs. It’s also about evaluating the trade-off between the costs and the benefits it provides. Here are some key considerations to keep in mind:

1. Immediate Capital: Invoicing discounting provides immediate access to cash, which is invaluable when acquiring a company with immediate cash flow needs. The cost of factoring may be outweighed by the benefits of completing the acquisition.
2. Risk Mitigation: Factoring can transfer the credit risk of your customers to the factor for non-recourse facilities. This can be especially beneficial if the company has a history of late payments.
3. Cash Flow Management: Factoring helps you maintain a predictable cash flow, which is essential for managing the integration of an acquired business.
4. Speed of Transaction: Factoring is often quicker than traditional financing methods, allowing you to complete the acquisition in a shorter timeframe.
5. Long-Term Goals: Consider how factoring aligns with your long-term financial and strategic goals. It may be a necessary cost for the short term, but you should also plan for transitioning away from factoring as your business stabilizes.

Case Study: A Practical Example

Let’s consider a hypothetical scenario to illustrate the true cost of invoicing discounting for acquisitions. Imagine you’re a mid-sized company looking to acquire a smaller competitor. The acquisition is estimated to cost £2 million, and you need to factor £1 million in invoices to fund the deal. The factor charges a 0.35% service fee and a 2% discount fee per annum.

• Service Fee: 2% of £1 million = £3,500 per month.
• Discount Fee: 2% + base rate of 5.25% of £1 million = £6,041 per month

Now, let’s assume that it takes six months to complete the acquisition and integrate the acquired company. During this period, you continue to draw £1,000,000 consistently, although invoices are being paid throughout the period. Therefore, you’ll incur the service fee and the discount fee for these six months:

• Service Fee for Six Months: £3,500 x 6 = £21,000
• Discount Fee for Six Months: £6,041 x 6 = £36,250

In this scenario, the total cost of invoicing discounting for the acquisition would be £57,250. This cost is a significant consideration when determining the feasibility of using factoring for acquisitions.

However, you must also weigh this cost against the benefits and the potential gains from acquiring the smaller competitor. For instance, if the acquired company brings in additional revenue, cost savings, or market share that outweighs the £57,250 expense, then factoring is a valuable financial tool.

Furthermore, keep in mind that this is a simplified example, and real-world scenarios can be much more complex. The cost of factoring will depend on factors like the specific terms you negotiate with the factor, the speed at which your customers pay their invoices, and the economic conditions at the time of the acquisition.

Alternatives to Invoicing Discounting

While invoicing discounting can be a useful financial tool, it’s not the only option available for financing acquisitions. Before committing to factoring, it’s essential to explore other financing alternatives that might offer more favourable terms or lower costs. Some of these alternatives include:

1. Asset-Based Lending: Asset-based lending involves using your company’s assets, such as accounts receivable, inventory, or equipment, as collateral for a loan. This can be an attractive option for businesses with unencumbered assets.
2. Traditional Bank Loans: Securing a bank loan for the acquisition can provide a more predictable and potentially lower-cost financing option. However, bank loans often require collateral and have more stringent credit requirements.
3. Private Equity or Venture Capital: Depending on the size and nature of your acquisition, you might consider partnering with private equity or venture capital firms. These investors can inject capital into your business in exchange for equity, which can help fund the acquisition.

Each of these financing options comes with its own set of pros and cons, and the choice will depend on your specific financial situation, the nature of the acquisition, and your long-term business goals.

Conclusion

Invoicing discounting can be a valuable financial tool for facilitating acquisitions by providing immediate access to capital. However, determining the true cost of factoring for acquisitions requires a comprehensive analysis of factors like service fees, discount fees, invoice volume, payment terms, factor reputation, and potential opportunity costs.

When evaluating the cost of factoring, it’s essential to consider the trade-off between the costs and the benefits it offers, such as risk mitigation, cash flow management, and the speed of transaction. Additionally, you should explore alternative financing options to ensure that factoring is the most cost-effective choice for your specific acquisition.

Ultimately, the decision to use invoicing discounting for acquisitions should align with your overall financial strategy and long-term goals. By carefully assessing the costs and weighing them against the potential rewards, you can make an informed decision that sets your business on a path to successful acquisitions and sustained growth.

If you think invoice discounting is a good funding option for your next business acquisition ,then get in touch. With over 60 factors and invoice discounters to chose from, we’ll connect you with suitable sources. We’ll also work with you to negotiate terms that suit your unique requirements and offer you precisely the support you want.

Get in touch today.