Construction invoice factoring: how it works and what it really costs

Why contractors run short of cash on profitable jobs

Construction is one of the few industries where you can win a profitable job and still run out of money doing it. You pay crews weekly and suppliers on 30-day terms, but your own invoices go through a pay application process, approval by the general contractor, the owner's draw schedule and often a "pay-when-paid" clause. Sixty to ninety days from work performed to money in the bank is common for subcontractors, and retainage of 5% to 10% can be held until the project closes out.

Factoring exists to close that gap. Instead of borrowing against your business, you sell specific invoices for cash now. Approval depends mostly on the creditworthiness of the customer who owes you, not only on your own credit, which is why it's often available to younger companies that can't yet get a bank line of credit.

How factoring works, step by step

1. You do the work and invoice. For construction, that's usually an approved progress billing or pay application.
2. You submit the invoice to the factor. Along with supporting documents: the subcontract, the approved pay app, sometimes lien waivers and proof the work was accepted.
3. The factor verifies. They confirm with the GC or owner that the invoice is valid and approved, and check the payer's credit.
4. You get the advance. Typically a large percentage of the invoice, often within a few business days of verification.
5. The customer pays the factor. A notice of assignment tells your customer to pay the factoring company directly, usually to a lockbox.
6. You get the reserve, minus fees. Once paid, the factor releases the remaining balance less its fee.

What it really costs: a worked example

Factoring fees are usually quoted as a percentage of the invoice per period, often per 30 days, sometimes in smaller increments after the first period. Here's an illustrative $60,000 progress invoice with an 85% advance and a fee of 2.5% for the first 30 days plus 1% for each additional 10 days.

Hypothetical fee schedule. 45 days rounds up to two 10-day increments after the first 30. Real schedules vary by factor, volume and customer risk.

You received about $51,000 up front in each case. If the GC pays in 60 days, you paid $3,300 to use roughly $51,000 for two months. Annualized, that's far more expensive than a bank line of credit. But if that $51,000 meets payroll and lets you start the next job instead of turning it down, the comparison isn't factoring versus a cheap loan. It's factoring versus the margin you'd lose.

Watch for fees beyond the headline rate: application or setup fees, per-invoice processing fees, wire fees, monthly minimums, and early termination fees if you leave the contract. Ask for the total cost on a sample invoice in writing.

Recourse vs non-recourse

In recourse factoring, if your customer doesn't pay, you have to buy the invoice back or replace it. Fees are usually lower because you keep the credit risk. In non-recourse factoring, the factor takes on the risk of the customer's insolvency, though usually not disputes over the quality of your work. Fees are higher and the definition of what's covered matters. Read the non-recourse clause closely; in construction, most non-payment is about disputes, back-charges and change orders, which non-recourse often doesn't cover.

Construction-specific issues that trip contractors up

• Retainage. Most factors won't advance against retainage, because it isn't due until closeout and may be reduced by punch-list disputes. Expect the advance to be calculated on the invoice net of retainage.
• Pay-when-paid and pay-if-paid clauses. If your subcontract says you only get paid when the owner pays the GC, the factor will price that delay in, and some won't take the invoice at all.
• Lien waivers. Conditional and unconditional waivers have to line up with the factor's payment flow. Signing an unconditional waiver before money arrives can weaken your position.
• Bonded and public jobs. Government and bonded projects can be attractive because payers are creditworthy, but some public contracts restrict assignment of payments. Check before you sign.
• Change orders. Unapproved change orders usually can't be factored. Get them signed.
• Customer relationships. A notice of assignment tells your GC you're factoring. Most are used to it, but ask how your key customers view it.

Factoring vs a loan or line of credit

Factoring isn't the only way to bridge slow pay. Compare it with the alternatives:

• Business line of credit. Usually cheaper per dollar and you draw only what you need, but harder to qualify for and often requires two or more years in business, solid financials and sometimes a personal guarantee.
• Working capital loan. A fixed amount repaid over months. Predictable, but you pay interest on the whole amount even if you only needed it for a few weeks. Our guide to working capital for contractors compares the main types.
• Supplier terms. Negotiating 60-day terms with your main supplier can be cheaper than any financing.
• Mobilization payments. On larger jobs, ask for a deposit or mobilization payment to fund the first weeks.

As a rough comparison, a $50,000 working capital loan at an illustrative 18% APR over 12 months costs about $5,008 in interest. If you only need the money for 60 days on each of a few invoices, factoring can come out similar or cheaper, and it scales with your billing. If you need cash every month indefinitely, a line of credit is usually the better long-term tool.

When factoring makes sense, and when it doesn't

It tends to fit when: you're a subcontractor with creditworthy GCs who pay reliably but slowly; you're growing faster than your cash allows; you can't yet qualify for a bank line; and your margins can absorb a few percent of the invoice.

Think twice when: your margins are thin; your customers routinely pay late or dispute invoices; most of your billing is retainage-heavy; or you'd be factoring every invoice forever to cover a business that isn't profitable. Factoring speeds up cash; it doesn't fix pricing. Our guide on how to bid construction jobs covers building financing costs into your numbers.

Questions to ask a factoring company

1. What's the advance rate, and is it calculated before or after retainage?
2. How are fees calculated, and in what time increments?
3. What other fees apply: setup, per-invoice, wire, monthly minimum, termination?
4. Is it recourse or non-recourse, and what exactly does non-recourse cover?
5. Do I have to factor all invoices, or can I choose (spot factoring)?
6. How long is the contract, and how do I end it?
7. How do you handle lien waivers, joint checks and pay applications?
8. How quickly do you fund after verification?

Frequently asked questions