Tens of millions of workers consider themselves gig workers, and the gig economy is not slowing down anytime soon. If you’ve ever worked as a contract worker, you know how hard it can be to get paid, even when there’s an agreement in place.
Working as a sort of cash advance contract, contract financing can help businesses get the money they would have gotten eventually, but sooner.
Overview: What is contract financing?
Contract financing is a type of unsecured business loan, with no collateral required, that works as an advance payment on a contract. A contract financing company lends you the money stipulated in your contract, working as a cash advance.
Then, when it comes time to invoice your customer, the financing company will take care of the financing, since the payment will go directly to the financing company instead of your business.
It’s important to note the differences between contract financing and a microloan, working capital, invoice factoring, and business installment loans. Sometimes all of those terms are used interchangeably, but they are not the same thing.
• Microloan: A microloan is a form of peer-to-peer lending where individuals, as opposed to banks, contribute a certain amount to your efforts. GoFundMe and Kickstarter are examples of microloan lending.
• Working capital loan: A working capital loan carries seasonal businesses through their slow times by providing short-term loans to businesses during less active business months. The money can be used to pay wages, vendors, and utilities.
• Invoice factoring: This is when you sell the debt owed to you in the form of invoices at a discount to another business, now known as the factor, and that factor becomes responsible for the collection of the money from your customer.
• Business installment loan: This type of loan is a fancy way of referring to a normal business loan, where a borrower is loaned money for a specific asset and payments are made in specified amounts over a specified period of time.
5 factors that help you qualify for contract financing
While it’s not a traditional type of loan, contract financing is still a loan, so a lender will look at certain factors to see if you qualify. These are the ones you’ll run into most often.
Time in business
One of the qualifying factors for contract lending is how long you’ve been in business. Most lenders will have a minimum, like six months, but it can vary depending on the lender and their lending cap.
Customer credit rating
Since your customer will be the one paying the financing company after they’ve issued your business the contract funding, the lender will look at the credit history and rating of the customer.
In normal lending situations, your own credit history would be a determining factor, but not in the case of contract financing.
Monthly billing amount
Contract financing lenders usually require your monthly billing amount. This doesn’t mean how many bills you pay per month, but rather how many customers you bill in a given month.
Basically, the lender wants to know that your billing amount is enough to cover the amount of the loan, even though you’re not the one actually paying it back. Since your customer is the one paying the financing company, if you’re not billing your customers enough to cover the amount of the loan, you may not qualify.
Signed contract with specific milestones
Before heading to a financing company, it will be helpful to have a signed contract in hand, outlined with specific milestones upon which you will be paid.
Here’s how milestones work.
• Each portion of a project is assigned its own milestone. For example, if you are remodeling a house, the first milestone might be demolition, depending on the scope of the project.
• Each milestone comes with a payment amount. This amount will be paid out to the contractor on the completion of said milestone.
There’s no limit on how many milestones a contract can have, as it is at the discretion of the two parties involved in the contract.
Positive work track record
You will also need to provide proof that you are an established contractor. By that, we don’t mean merely that you’ve been around for a while. It just means you have a record of completing projects in the contracted time frame.
This helps ensure that the lender isn’t handing over money for a project that will be delayed, which will in turn delay your invoicing process, which leads to a delay in the financing company getting their money back from your customer.
Example of contract financing
Let’s continue with the example of remodeling a house. A contract is written up with the total payment amount to be $50,000. That payment is then broken down into different milestones, each with its own payment amount. We’ll say there are five milestones at $10,000 a piece.
Now, the payment schedule is that your customer will pay out 60 days after invoicing, and you’ll invoice after each milestone. Assuming you invoice the same day you finish each milestone, you won’t receive payment for two months after that portion of the project is completed.
But you need an advance on that money so you can continue to pay your workers and buy materials. That’s when you turn to a contract financing company.
A contract financing company will advance a certain percentage, let’s say 90%, of each of the $10,000 milestones to you at the time of invoice, and will then request the normal invoice payment from your customer.
That payment will go directly to the financing company instead of you, and you will receive the remaining 10% left out of the initial cash advance.
How to get contract financing
Now that you know what you’ll need to qualify for contract financing and a little bit more about how it actually works, let’s get right into how you can actually obtain contract financing.
1. Create contract as normal with your customer
The first step to acquiring this type of money lending contract is to create the contract with your customer as you normally would. You’ll need to take this to the contract financing company so they know how much financing you need.
2. Present any qualifying information
Next, you’ll present all of the qualifying factors listed above, like years in business, work completion history, and monthly billing amount.
If the financing company needs the credit history of your customer, they will get that information from your customer and not you.
3. Submit milestone invoices to financing company
Once you’ve completed a milestone, you will submit an invoice to the financing company. The financing company will then invoice your customer to recoup the money they pay out to you.
4. Get paid
As mentioned above, you will receive a certain percentage of the invoice amount upfront, and then the rest once the invoice has been paid in full by your customer to the contract financing company.
This advance in cash flow can be used to purchase materials and supplies, to pay wages, or to cover anything else associated with this particular project.
5. Wait for invoice to be paid to financing company, then get remainder of payment
If your payment term is 60 days, you will receive the remaining percentage of the milestone payment 60 days after the contract financing company invoices your customer.
There are sometimes fees associated with contract financing companies, so be sure to look into that before choosing one. You don’t want to end up getting significantly less money out of your contract.
Do you really need contract financing?
If you’re trying to find small business loans that suit your specific needs, notably contract financing, using this guide to figure out how to go about that will set you on the right path.
Small businesses working project to project might not always have the money to front the materials and wages needed to complete a job. Contract financing exists to ensure that you can complete the project as you normally would, but get your money a lot sooner.
Original source: The blueprint