Factoring Construction Receivables: When It Makes Sense and When It Doesn't
Factoring is the sale of accounts receivable to a third-party funder (the factor) in exchange for immediate cash. The contractor submits the invoice to the factor, the factor pays a percentage of the invoice face value upfront, the factor collects from the end customer when the invoice comes due, and the factor remits the remaining balance minus their fees.
In construction, factoring is a niche tool — widely advertised to contractors but used by a minority. It solves a specific problem (immediate cash when receivables are stretched) at a specific cost (1.5-5% of invoice value, annualized to effective interest rates often in the 15-35% range). Whether it makes sense depends on the contractor's situation, the alternatives available, and the specific factoring terms.
A typical factoring arrangement:
Standard factoring mechanics
- Contractor completes work and submits invoice to customer
- Contractor sells the invoice to the factor
- Factor pays the contractor an advance (typically 70-90% of invoice face value) immediately
- Factor takes over collection — customer pays the factor directly
- When the customer pays the factor, the factor remits the remaining balance (the reserve) to the contractor, minus their fees
The factor's fee is structured as a discount on the invoice value, often calculated based on how long the invoice takes to collect. A typical structure: 1.5% for the first 30 days, additional 0.5-1% per 15-day increment after that. An invoice that takes 60 days to collect might end up costing 3.5% in total fees. An invoice taking 90 days might cost 5% or more.
Factoring arrangements are either recourse or non-recourse:
Recourse vs non-recourse factoring
- Recourse — the contractor remains responsible if the customer doesn't pay. If the customer defaults, the factor charges the receivable back to the contractor. Cheaper fees because the factor's risk is lower.
- Non-recourse — the factor assumes the credit risk. If the customer defaults, the factor absorbs the loss. More expensive fees because the factor is taking on credit exposure.
Non-recourse factoring typically costs 1-2% more than recourse for similar invoices. Most construction factoring is recourse, partly because construction receivables have specific risks (lien claims, back-charges, change order disputes) that factors don't want to underwrite, and partly because contractors are typically underwritten themselves as the credit risk.
Construction receivables have complications that staffing or manufacturing receivables don't, and factors have learned to either charge premiums or avoid them:
Construction-specific complications for factoring
- Retention — the full invoice face value isn't collectible until after retention release, which may be 12+ months out. Factors typically can't factor retention cleanly.
- Lien rights — the contractor's lien rights interact with the factor's rights in the invoice, creating legal complexity
- Back-charges — the final collectible amount may be reduced by GC back-charges, affecting the factor's expected recovery
- Change orders — unapproved change orders may or may not be collectible, making the factored amount uncertain
- Pay-when-paid clauses — on subcontract receivables, the sub doesn't get paid until the GC is paid, which the factor may not have visibility into
- Progress billings subject to dispute — pay applications can be disputed by owners, reducing collectibility
These complications typically push factors to either charge high fees, require recourse structures, or avoid construction entirely. Some factors specialize in construction and have built in the expertise; these tend to charge more than generic factors but know what they're looking at.
A specific example: a contractor has a $200,000 invoice that will collect in 60 days. The factor offers:
Sample factoring deal math
- 85% advance: $170,000 paid to contractor immediately
- Fee structure: 1.5% for 30 days, plus 1% for the next 30 days = 2.5% total fee
- Factor's total fee: 2.5% × $200,000 = $5,000
- Customer pays factor $200,000 in 60 days
- Factor releases reserve: $200,000 − $170,000 (advance) − $5,000 (fee) = $25,000 to contractor
- Total collected by contractor: $170,000 + $25,000 = $195,000 on a $200,000 invoice
$5,000 fee on $200,000 advanced for 60 days is an effective annualized rate of 15% (5,000 / 170,000 × 365/60 = 17.9%, roughly). Recurring monthly factoring at this scale runs annualized costs around 15-20% for most recourse arrangements.
Compare that to typical commercial bank line-of-credit rates (prime + 1-3%, perhaps 9-11% all-in for most contractors). Bank financing is almost always cheaper than factoring — but it's also harder to get, especially for growth-stage contractors without strong working capital or real estate collateral.
Get AP insights in your inbox
A short monthly roundup of construction AP + accounting posts. No spam, ever.
No spam. Unsubscribe anytime.
Factoring is rarely the cheapest capital. It's sometimes the only capital available to a growth-stage contractor who can't qualify for bank financing. That's when it makes sense — not because it's good, but because the alternative is worse.
Situations where factoring can be the right answer
- Rapid growth with insufficient bank financing — the contractor's growth rate exceeds what the bank will fund, and receivables are the company's main asset
- Startup or newly-formed contractors without bank credit history — factoring can bridge the gap until banking relationships mature
- Seasonal cash flow gaps in small contractors — a three-month stretch of tight cash can be bridged with selective factoring on specific large invoices
- Growth-stage contractors bidding work that will stretch working capital — factoring specific high-value receivables lets them take on work they otherwise couldn't
- Pay-when-paid situations where upstream GCs are slow — factoring can restore cash flow even when the GC takes 90+ days
In each of these cases, the contractor weighs the factoring cost against the alternative. If the alternative is "can't take the project" or "miss payroll," factoring at 15-20% annualized cost is often the right answer. If the alternative is a bank LOC at 10%, factoring is the wrong answer.
Established mid-market contractors rarely benefit from factoring. They typically have bank relationships, acceptable receivables aging, and working capital management that doesn't require selling receivables at a discount. When an established contractor considers factoring, the usual reason is a short-term cash crunch — which often points to deeper problems (persistent under-billings, slow collections, cost overruns) that factoring doesn't solve. Factoring in those situations is treating a symptom without addressing the cause, and the ongoing fees become a permanent drag.
There's a soft cost to factoring worth mentioning. When invoices flow through a factor, the customer knows — they're paying the factor, not the original vendor. Some customers associate factoring with financial distress and may tighten their own credit terms with the contractor. Sureties sometimes view factoring as a negative signal in bonding underwriting.
This doesn't mean factoring is bad, but it does mean contractors should factor deliberately, not routinely. Factoring one invoice to smooth a specific cash-flow gap sends a different message than factoring every invoice to cover operating costs.
Alternatives to factoring for cash flow
- Bank line of credit — typically cheaper if available
- SBA loan — for longer-term capital needs, often below market rates for qualifying small businesses
- Equipment financing — against specific equipment purchases, typically cheaper than factoring
- Retention bond — frees up retention cash without selling receivables
- Tighter pay application discipline — accelerates collections without third-party fees
- Customer credit terms negotiation — sometimes customers will pay faster for a small discount, cheaper than factoring
- Supply chain finance programs — some large GCs offer early-payment discount programs to their subs
Factoring construction receivables is a tool with specific uses. It provides immediate cash in exchange for 1.5-5% of invoice face value, annualized to effective rates that are typically 2-3x bank line-of-credit pricing. For growth-stage contractors with limited bank access, it can be the enabler of taking on work otherwise out of reach. For established contractors, the math rarely works — other capital is available at lower cost. Before factoring, a contractor should verify there's no cheaper alternative and that the specific situation (growth, gap, or structural) actually fits what factoring is designed to solve.
Written by
Sarah Blake
Head of Product
Former AP Manager at a $200M construction firm, now leads product at Covinly. Writes about what AP teams actually need from automation — beyond the marketing promises.
View all posts