Meet Roger (not his real name) - an interim CFO and a fully paid up receivables financing (RF) junkie. He’s used funding against invoices to grow multiple businesses, including a retailer and a marketing agency. But at times, he said, it felt like riding a rodeo bull. He’s seen companies screw it up in all sorts of ways:

“Suddenly you can’t get funding against a £1 million invoice. You can’t buy stock or pay wages. We fixed it by reducing sales to that client and selling more to others. But there were [nerve shredding] moments. It’s not nice going home at night worrying where the money will come from,” said Roger.

Yep, RF can go wrong in myriad ways. But with careful planning and guardrails, CFOs can control it and avoid big problems.

Before you jump into using RF, be super clear about what you’re using it for. If it’s to fund working capital and support growth, you might be on the right track. If it’s to invest in long term assets, like CapEx or paper over losses, think again.

“It works well if you need short-term funding to execute the invoiced work before you get paid, especially by a large or blue-chip customer,” said Matthews. “RF goes wrong if you use it to plug another gap, or if your revenue is declining, which reduces your borrowing base, making it hard to exit.”

“If you have wider, long-term funding needs, look elsewhere.”

RF is enticing because it’s relatively easy to access, making it feel like a quick fix. But, if the news has taught us anything this week, it’s beware the honeypot. RF is relatively expensive. Full annualized costs including processing fees and interest rates can be two or three times those for a typical bank loan.

And it’s complicated. Specific terms CFOs need to know include:

Phillip Zagotti, an attorney at North Star Law Firm, warned that dilution is one to keep an eye on. If it starts creeping up, your lender could increase reserves or cut your advance rate. And, as Zagotti pointed out, that’s often when you can least afford it.

Interest rates are another thing to watch. Your lender could hike the rate after you’ve signed up, so make sure your margins can handle the extra cost. As Zagotti put it: “I’ve seen companies with thin profit margins get a 15% factoring charge on top. It doesn’t end well.”

It’s also worth leaving yourself some headroom on borrowing. Ian Matthews, CFO at fractional provider Third Road Management, said: “If the bank offers to lend you 80% of receivables, plan to only borrow 60%. If you need to draw 100% all the time, you have an underlying issue and should look at other funding options.”

Before you sign up, double-check that your receivables aren’t already tied up elsewhere. Look out for existing debentures or other agreements that might give someone else a claim over them.

“Never stack one RF facility on another,” said Zagotti. “I've had to unwind stacked situations. By then, few good options are left. So pay off or renegotiate existing receivables-based contracts first.”

Check who’s liable for what. Especially if you are in a small business, which can come with a ton of personal risk.

“Beware owners signing personal guarantees, which some contracts insist on. Businesses go bust all the time. You don’t want someone risking their house,” said Fractional CFO Scott Baybrook.

And make sure someone owns it. “Someone has to be in charge and responsible for meeting the facility’s requirements,” said Matthews.

Go over the customer concentration limit, and a big chunk of your borrowing base could disappear. But that’s not the only risk. Your lender might also stop you borrowing against certain invoices if a customer’s credit rating takes a hit. Or they could slap a reserve on those invoices, cutting how much you can borrow.

Once you start an RF facility, monitor your customers’ credit scores and concentration levels. These can be real bear traps, easily missed when you're too focused on more obvious problems like bad debt.

Martin Spiller is an associate professor at Oxford Brookes Business School, and has worked as a fractional CFO for 25 companies. He said it’s easy to get caught out by such terms: “You don’t want the funding to be cut because your customer concentration changes. If that happens while you’re growing, it could be catastrophic.”

To establish some governance and control, aim for the following:

Have an exit plan from day one. While you’re using the facility, focus on building a solid set of accounts and a clean credit history. Use the time to tackle the underlying issues too, like high debtor days and poor payment terms. Then, as soon as you qualify for more robust, permanent, funding, make the switch.

If you’re using RF to cover seasonal cash needs, make sure you really do pay it down when the season ends. Start the next season with a clean slate, or you just used a short term funding source to underwrite a permanent funding need… a no-no with RF.

Scott Geller, partner at independent CFO provider PathPredict, specializes in staffing companies. He said it can be hard to grow such businesses without RF. But clients often ask for his help in switching to cheaper funding sources.

One company started with factoring because it was more accessible than bank credit. They had to use the facility for ten years before they could replace it with cheaper bank credit.

“It required a strong bank relationship and many calculations to confirm the new credit line was enough to meet their continued growth plans,” said Geller. “They couldn’t borrow as much because the bank wouldn’t lend against one heavily concentrated client.”

Switching was hard work, as they had to move invoicing and accounts receivable in-house. That included getting payroll and other data from the factoring company, which “wasn’t a whole lot interested” in helping, said Geller.

It took ten years, a lot of legwork, and some awkward conversations, according to Geller. But they proved that factoring doesn’t have to be a permanent fixture.