Background
Nontraditional business collateral grew as lenders and alternative financiers looked for ways to lend to small businesses and startups that didn’t own valuable physical assets. Instead of a mortgage or equipment lien, lenders evaluate the predictable cash flow from receivables (invoices owed by customers) or the revenue streams spelled out in contracts.
How lenders value receivables and contracts
- Credit quality of your customers or contract counterparty: higher-rated payors increase acceptability. (See CFPB guidance on business lending risks: https://www.consumerfinance.gov)
- Age and collectibility of receivables: many lenders apply discounts or only accept receivables under 90 days past invoice.
- Contract terms and enforceability: fixed-price, non-cancellable contracts with clear payment schedules are stronger collateral.
- Dilution factors: disputed invoices, customer credits, and returns reduce usable collateral value.
Typical structures
- Accounts receivable financing (factoring or invoice financing): you pledge or sell invoices for an advance. For background see our article on factoring: https://finhelp.io/glossary/factoring/ and the overview “Invoice Financing and Factoring: Getting Paid Faster”: https://finhelp.io/glossary/invoice-financing-and-factoring-getting-paid-faster/
- Contract-backed loans: lenders take a lien on contract proceeds or set up a lockbox to receive payments directly.
- Purchase order or equipment financing tied to contract performance.
Real-world examples
- A construction contractor pledges a signed payment schedule from a municipal project to secure an equipment line of credit.
- A B2B service firm uses a portfolio of invoices to obtain a short-term advance from a factor so it can meet payroll.
In my practice of advising small businesses, I’ve seen deals close faster when owners bring organized documentation—aged receivables, signed contracts, and customer credit references—because those materials directly reduce lender due diligence time.
Who can use this option
Eligible businesses typically have:
- Predictable, documented receivables or signed contracts with creditworthy payors; and
- Procedures for invoice tracking and collections.
Startups without long operating histories can still qualify if they have firm, enforceable contracts with established companies.
Preparation checklist (what lenders will ask for)
- Aged receivables report and invoices.
- Copies of signed contracts and any amendment or change orders.
- Customer credit information or historical payment patterns.
- Evidence of no undisclosed liens on the same collateral.
- Bank statements and basic financials to confirm operating cash flow.
Professional tips
- Clean records: present a detailed AR aging schedule and invoice copies grouped by client.
- Segregate pledged receivables: avoid mixing pledged and unpledged invoices to prevent disputes.
- Negotiate advance rates: typical advance rates vary (often 70–90% for high-quality invoices); compare factoring vs. invoice discounting (see: https://finhelp.io/glossary/invoice-factoring/).
- Understand fees: factoring, lockboxes, and monitoring add costs—calculate net proceeds before committing.
Common mistakes and misconceptions
- Overvaluing receivables: lenders apply haircuts—don’t assume face value equals borrowing base.
- Ignoring counterparty risk: invoices from low-credit customers may be discounted or rejected.
- Over-pledging the same asset: multiple claims on the same receivables create legal and collection problems.
Costs and risks
- Higher effective cost than secured loans on real estate for many small businesses.
- Potential impact on customer relationships if customers are notified of collection by a third party.
- Operational risk: lenders may require control mechanisms (lockboxes, direct remittance instructions) that change payment flow.
When to choose this option
- You lack real-estate or equipment collateral but have steady invoiced revenue or firm contracts.
- You need working capital fast and can absorb the cost structure of receivable financing.
Links to related guidance
- For mechanics of receivables financing and how it affects your balance sheet, see “Using Receivables Financing to Smooth Cash Flow”: https://finhelp.io/glossary/using-receivables-financing-to-smooth-cash-flow/
- For tradeoffs between factoring and other short-term options, see our comparison pieces on factoring and short-term lines: https://finhelp.io/glossary/invoice-factoring-vs-short-term-lines-making-the-right-choice-for-cash-flow/
FAQ
Q: Can I pledge future contracts that haven’t yet generated invoices?
A: Yes—lenders may accept signed, enforceable contracts as collateral, but they will underwrite based on counterparty credit and contract enforceability.
Q: Will using receivables financing hurt my ability to get other loans?
A: It can; a lender who takes a first lien on receivables may block other lenders from using the same collateral. Always check intercreditor terms.
Regulatory and authoritative references
- Consumer Financial Protection Bureau — business lending and borrower protections: https://www.consumerfinance.gov
- For tax treatment questions related to selling receivables or factoring, consult IRS guidance and a tax advisor (IRS: https://www.irs.gov).
Professional disclaimer
This article is educational and reflects common industry practice as of 2025. It is not personalized financial, legal, or tax advice. Consult a lender, attorney, or tax professional before using receivables or contracts as collateral.
