Collateral is property pledged to secure a financial obligation. If the obligation is not met, the secured party can enforce its rights against that property, for example by collecting it, taking possession of it or selling it.
How it works in factoring
In factoring, the invoices themselves are the central asset. Strictly speaking, a factor buys the receivables rather than holding them as collateral, but Article 9 of the Uniform Commercial Code treats sales of accounts much like security interests for filing and priority purposes. So the factor files a UCC-1 describing the receivables, just as a lender would for collateral.
Factors often take a broader security interest as well, to cover obligations such as repurchasing unpaid invoices under recourse terms, fees, and losses from breaches of warranty. That added collateral might include:
- All accounts, whether or not factored
- Inventory and equipment
- Deposit accounts
- General intangibles
Lenders in asset-based lending take a similar approach but usually lend against a borrowing base calculated from the value of eligible collateral.
What to check
- Exactly what collateral the agreement and UCC filing describe
- Whether the collateral reaches assets you might want to finance elsewhere, such as equipment
- What happens to collateral at the end of the relationship
- Whether a personal guarantee is also required, which puts personal assets at risk in addition to business assets
The broader the collateral description, the harder it may be to bring in a second financier later without an intercreditor agreement.