Startup

How to Start a Factoring Business in India?

Factoring has gained popularity around the world, particularly in India. It is a financial service that turns receivables into immediate cash. This novel solution aids contemporary industries in dealing with their cash flow. Factoring is particularly beneficial to micro, small and medium enterprises in India as they lack access to traditional loans.

Non-Banking Financial Companies (NBFCs) have also played a significant role in encouraging factoring in the Indian market while also enjoying a strong regulatory environment from the Reserve Bank of India and the Factoring Regulation Act, 2011.

This blog outlines a series of stages necessary for starting a factoring business in India, covering its regulatory environment, operational requirements, challenges, and strategies for success.

Understanding Factoring and Its Importance

What is Factoring?

Factoring is a transaction in which a business sells its invoices to a receivables factor at a discounted rate, usually an NBFC or a bank, in order to get immediate cash. It bridges the gap between the raising of an invoice and the collection of payment, thereby enabling a business to maintain liquidity to support its operations.

The Factoring Regulation Act, 2011, defines factoring as the acquisition of receivables by assignment or financing against receivables. It categorically excludes the provision of conventional credit facilities, transactions relating to agricultural produce and specified financial services.

Importance of Factoring in India

MSMEs are the backbone of the Indian economy, making a substantial contribution in terms of GDP and employment. This sector is generally hampered in growth due to liquidity constraints. Factoring allows the business enterprise to draw on funds against receivables.

Despite its advantages, factoring accounts for an infinitesimal fraction of MSME credit in India. This unexploited potential and recent regulatory reforms offer enormous opportunities for entrepreneurs willing to set up factoring businesses.

Role of NBFC – Factors in Factoring Services

What is an NBFC-Factor?

An NBFC-Factor is a non-banking financial company whose principal business is factoring. To be classified as an NBFC-Factor, a company should:

• Derive at least 75% of its total financial assets and gross income from factoring.
• Maintain at least a Net Owned Fund (NOF) of ₹5 crore.
• Obtain a Certificate of Registration from RBI under the Factoring Regulation Act, 2011.

NBFC factors serve as an important link to connect businesses to financial structures while offering personalised liquidity solutions to them.

Steps to Establish a Factoring Business in India

STEP 1. Incorporate a Company

The journey begins with the incorporation of a company under the Companies Act, 2013, for which the object of the company, as reflected in the Memorandum of Association, has to expressly include factoring along with other financial activities.

STEP 2. Meet Entry Point Criteria

To be classified as an NBFC-Factor, an organization should satisfy the following conditions:

• Net Owned Fund: The minimum NOF required is ₹5 crore. In the case of companies converting as NBFC-Factor, the transition period, if any, as permitted by RBI, may be allowed.
• Principal Business Criteria: At least 75% of the financial assets and gross income must come from factoring.

STEP 3. Registration with RBI

The eligibility to operate as NBFC-Factor necessitates its NBFC registration with RBI. Any application includes:

• Filing the application under Section 3 of the Factoring Regulation Act, 2011.
• Providing necessary documentation, including:
• Certificate of incorporation
• Audited financial statements
• Business plans focusing on factoring activities
• Compliance evidence for PBC requirement

Existing NBFCs converting to become NBFC – Factor shall, while converting into NBFC-factor, surrender the original CoR.

STEP 4. Build Operational Infrastructure

A successful factoring business calls for a formidable operational framework, including:

• Credit Analysis: It is the analysis of the creditworthiness of the debtors.
• Risk Assessment and Management: Establishing controls over exposure to credit in cases of “without recourse” factoring.
• Technology Integration: Engaging with the digital world by providing online systems for submitting invoices, following up on customer payments, and directly contacting customers.

STEP 5. Comply with Regulatory Requirements

It must adhere to the Factoring Regulation Act, 2011, and the directives issued by the RBI. The major areas of compliance include:

• Asset Classification: Receivables unpaid for over six months must be classified as Non-Performing Assets (NPAs).
• Prudential Norms: The ratio of capital adequacy and provisioning for NPAs should be sufficient.
• Reporting: The submission of periodic reports on factoring portfolios and financial performance to the RBI.

Regulatory Framework Facilitating Factoring in India

➢   Recent Amendments:

The Indian regulatory framework has been changing considerably to encourage factoring. The recent amendments include:

• Increased Eligibility: The new Factor Registration Regulations, 2022, have increased the eligibility of NBFCs for factoring from 7 to 182 entities.
• Smoothening of Processes: According to the Assignment Registration Regulations, 2022, trade receivables have to be registered with the Central Registry within a period of 10 days from the date of assignment. This would ensure transparency and reduce the risks of double financing.

➢   Export and Import Factoring:

The factoring services involving cross-border trade should duly conform to the Foreign Exchange Management Act, 1999, for which prior approval from the Foreign Exchange Department of RBI is required, along with adherence to the guidelines laid down under FEMA.

Challenges in Starting a Factoring Business in India

While factoring brings immense opportunities, entrepreneurs have to consider a number of challenges in starting a factoring business in India:

1. Regulatory Barriers:

The stringent entry requirements of high NOF thresholds and compliance obligations discourage smaller NBFCs from entering the factoring market.

2. Credit Risk Management:

Factoring usually involves taking on credit risks, especially in “without recourse” transactions, where the factor bears the risk of non-payment by the debtor. There is a need for effective risk assessment and mitigation strategies.

3. Limited Awareness:

Very few MSMEs are aware of the various benefits of factoring. The general lack of awareness restricts the market penetration at large, especially in rural and semi-urban areas.

4. Competition from Traditional Financing:

All products in the market are dominated with conventional financial alternatives being overdrafts and cash credits. Factoring businesses need, therefore, to devise ways of shaping different products to compete effectively.

Strategies for Success in the Factoring Business in India

To be successful in the competitive factoring market, businesses have to be innovative in their strategies for accomplishing success in the factoring business in India.

1. Emphasis on MSMEs:

Provide factoring solutions that are specifically tailored to meet the unique challenges of MSMEs, such as irregular cash flow and limited access to credit. Align with government initiatives that focus on increasing financing for MSMEs.

2. Leveraging Technology:

Invest in advanced technology platforms that can reduce friction in operations. Leverage AI and data analytics in credit assessment, fraud detection, and automation of processes.

3. Risk Diversification:

Spread the exposure among different industries and geographies to reduce the risks of sectoral slowdowns; establish clear underwriting limits for high-risk clients.

4. Create Strategic Alliances:

Integrate banks, fintech platforms, and trade networks to reach out. Be involved with government initiatives, including the Trade Receivables Discounting System, for greater outreach and visibility.

5. Improved Market Awareness:

Targeted marketing campaigns and workshops can be done explaining the benefits to businesses. Benefits of factoring may be explained and elaborated especially on immediate liquidity and improved management of cash flow.

Opportunities in India’s Factoring Landscape

The factoring ecosystem in India is at the threshold of exponential growth, and the fertile ground has been laid by regulatory reforms, technology, and increased awareness. Besides, financial inclusions and support to MSMEs aligns with the government vision on economic development.

To Wrap Up

Setting up a factoring business in India holds a lot of promise and can unwittingly sort out the critical liquidity problems of businesses, especially MSMEs. Though the regulatory environment and operational complexities may appear daunting, a well-thought strategy and strict adherence to compliance requirements would promise a smooth sail.

As the factoring ecosystem matures, it is entrepreneurs with strong technology, real customer-centricity, and powerful partnerships who will unlock great opportunities. Since factoring businesses align very strongly with India’s goals about financial inclusion, they can play an actually transformative role in the country’s economic growth.

To get expert assistance in kickstarting factoring business in India, visit https://enterslice.com/.

Frequently Asked Questions