The federal government is legally required to pay invoices within 30 days under the Prompt Payment Act (31 U.S.C. §§ 3901-3907). In practice, many small contractors wait 45 to 90 days or longer, particularly on cost-type contracts, contracts with multiple approval layers, or contracts with invoice disputes. For a small business carrying payroll every two weeks, a 75-day payment cycle on a $250,000 contract means carrying $100,000 or more in receivables with no cash in hand.
Invoice factoring is the mechanism that converts those receivables into cash now. The factoring company buys your invoice at a discount and collects directly from the government agency. You get most of your money immediately. The factoring company takes 1-5% of the invoice value as its fee.
The mechanics of factoring
You submit an invoice to the government agency for work completed. Instead of waiting 60 days for payment, you sell that invoice to a factoring company. The factoring company advances you 80-90% of the invoice face value immediately, typically within 24-48 hours.
When the government pays, it pays the factoring company directly. The factoring company keeps its fee (the "discount rate" or "factoring fee") and sends you the remaining reserve balance.
Example: You invoice a DoD agency $100,000. The factoring company advances you $85,000 (85% of face value) on day one. The agency pays the factoring company $100,000 on day 60. The factoring company keeps $2,500 (2.5% of $100,000 as the factoring fee) and sends you the $12,500 reserve. Your net proceeds: $97,500 over 60 days. Your cost: $2,500, or effectively 5% annualized on the $85,000 you received for 60 days.
The Assignment of Claims Act and how to set it up
Factoring a federal government invoice requires compliance with the Assignment of Claims Act of 1940 (31 U.S.C. § 3727; 41 U.S.C. § 6305). The Act governs how contractors can assign rights to receive payment under federal contracts to a third-party financial institution.
Federal contracts may not be assigned to private parties, but the right to receive payment under a contract can be assigned to a bank, trust company, or Federal Reserve Bank.
The practical steps:
- Your contract must have an assignment of claims clause, or the contracting officer must agree to add one. Many federal contracts include FAR 52.232-23 (Assignment of Claims) by default.
- Your factoring company sends a Notice of Assignment (NOA) to the contracting officer and the designated payment office.
- The contracting officer acknowledges the assignment. This tells the government to make future payments to the factoring company rather than you.
- You submit invoices as normal. The government pays the factoring company.
The NOA process adds 1-2 weeks compared to factoring a commercial invoice. For the first transaction on a new contract, expect 2-3 weeks to get the assignment recognized. Subsequent invoices on the same contract are faster because the assignment is already in place.
Not all contracting officers are familiar with Assignment of Claims. Some push back. The FAR explicitly authorizes it, so a contracting officer who objects can be directed to FAR 32.802 and the DFARS equivalent (for DoD contracts). If you are working with a prime contractor as a subcontractor, note that Assignment of Claims applies to direct federal contracts, not subcontracts. Subcontractor factoring works on the same advance/discount model but without the federal assignment mechanism.
What factoring costs in practice
Factoring fees are quoted as a percentage of the invoice face value, typically expressed per 30-day period. A 1.5% per month fee on a $100,000 invoice means you pay $1,500 for the first 30 days, $3,000 if the invoice takes 60 days to pay, and so on.
Market rates as of 2024 for government contract factoring:
- Prime (AAA-rated agency): 0.75-1.5% per 30 days
- Standard federal agencies: 1.5-3% per 30 days
- Disputed or slow-paying invoices: 3-5% per 30 days
- New relationship, unverified contract: Higher rates until track record is established
The advance rate (how much you get upfront) varies from 70% to 92% depending on the factoring company and the creditworthiness of the government payer. Government payers are among the most creditworthy in the world, so advance rates for federal contracts tend to be at the high end.
Watch for additional fees: application fees ($250-$500), due diligence fees, wire transfer fees ($25-50 per transaction), and reserve holdback periods. A factoring quote that looks like 1.5% per month may have hidden fees that push the effective rate to 2.5%.
Recourse vs. non-recourse factoring
In recourse factoring, if the government does not pay (dispute, contract modification, funding lapse), you are responsible for repaying the advance. For federal government receivables, recourse risk is low because the government does pay eventually on legitimate invoices.
In non-recourse factoring, the factoring company takes the credit risk. If the government does not pay, the factoring company absorbs the loss. Non-recourse factoring costs more, typically 0.5-1% more per period. For government contracts with clear deliverables and no outstanding disputes, the extra cost is usually not worth it.
Factoring vs. a line of credit: when each makes sense
Factoring is better when: - You do not qualify for a bank line of credit (credit score under 650, under two years in business) - You have lumpy revenue with occasional large invoices rather than steady cash flow - You need capital immediately and cannot wait weeks for loan approval - You want financing that scales automatically with your contract revenue without reapplying
A line of credit is better when: - You have established banking relationships and credit history - Your cash flow needs are recurring and predictable - You want lower all-in cost of capital (a bank line at prime plus 2% costs less than factoring in most scenarios) - You do not want to involve a third party in your government payment process
For a new contractor winning their first federal contract, factoring is often the only accessible option. For an established contractor with two or more years of federal contract history, a bank line of credit secured by federal receivables (through a commercial bank that understands government contract lending) is usually cheaper.
Factoring companies that specialize in government contracts
Not all factoring companies understand federal contracting. Working with one that does saves significant time on the Assignment of Claims paperwork.
Factoring companies with documented experience in federal government contracts include Triumph Business Capital (formerly Advance Business Capital), Crestmark (part of MetaBank), RTS Financial, and lenders within the SBA Community Advantage program. Several CDFIs also offer government contract factoring at below-market rates.
When evaluating a factoring company, ask: - How many federal government contracts have you factored in the last 12 months? - Do you handle the Notice of Assignment paperwork directly? - What is your advance rate for DoD/VA/GSA schedule invoices specifically? - What are all fees, not just the discount rate?
When factoring is a bad idea
Factoring a disputed invoice is almost always a bad idea. If you and the contracting officer disagree about whether the deliverable was acceptable, the government will not pay, and you will owe the advance back under recourse factoring.
Factoring an invoice on a contract that is about to end, or where you have no follow-on work, is expensive relative to alternatives. The setup costs and due diligence time make factoring most efficient when you have recurring invoices under the same contract.
Factoring is not a substitute for financial management. If you are factoring every invoice because you have no cash reserves, the factoring fees compound and erode your margins. Build a cash reserve equal to at least one payment cycle before relying on factoring as your primary liquidity tool.
How to start
- Identify the specific invoice you want to factor and pull the contract payment terms.
- Contact two to three factoring companies and request a quote specific to your contract type and agency.
- Verify whether your contract contains FAR 52.232-23. If not, contact your contracting officer to discuss adding it.
- Compare quotes on an all-in cost basis: advance rate, factoring fee per 30 days, and all additional fees.
- Once you select a factor, allow 2-3 weeks for the NOA process on your first transaction.
Factoring is a legitimate, widely-used financing tool. It is expensive compared to bank debt, but it does not require credit history, does not dilute equity, and scales directly with your contract revenue. For a small contractor managing their first federal contract, it is often the most practical path to positive cash flow.
