Navigating California’s Disclosure Law: Key Compliance Insights for Factoring Funders and Their Partners
Written by: Thomas J. Ingrassia - Chief Risk Officer, CapFlow Funding Group
The regulatory landscape for commercial finance in California has undergone a transformation, notably affecting direct factoring funders and their referral partners. As of December 2022, the California Department of Financial Protection and Innovation (DFPI) has enforced a disclosure law aimed at increasing transparency in alternative financing. This law extends to factoring companies, mandating detailed disclosure of fees, terms, and estimated annual percentage rate (APR) equivalents.
While California’s law is intended to help small business borrowers compare competing offers, it poses unique challenges for factoring funders whose business models differ from traditional financing products. These new requirements mean that both direct funders and their partners must navigate complex compliance mandates which may reshape how they market, disclose, and deliver their services. For direct funders and referral partners working together to offer factoring services, ensuring compliance with the DFPI’s disclosure law is critical—not only for legal reasons but also to maintain trust and credibility in a competitive market.
California's Disclosure Law: What It Means for Factoring Companies
California’s commercial financing disclosure law requires all financing providers to disclose key terms, including the total cost of financing, total repayment amount, and estimated APR. While calculating APR makes sense in traditional loan structures, it is not a standard metric for factoring, which involves purchasing receivables at a discount rather than charging interest on principal amounts. However, the law mandates this disclosure, requiring factoring firms to adapt.
For direct funders, this requires recalculating their cost structures to present an APR-equivalent, even though it doesn’t align naturally with factoring’s unique structure. Funders must also ensure that their partners, particularly ISOs involved in deal origination, understand and effectively communicate these changes to potential clients. Additionally, disclosures on potential fees, terms, and repayment amounts must be provided upfront to enable to applicant to make a more informed decision. Clearly placing an extra emphasis on transparent and standardized communication.
DFPI Oversight: Enforcing New Standards in Factoring
The DFPI, as the regulatory body behind this law, has demonstrated an active approach in holding commercial financing providers accountable. Direct factoring funders, in particular, are under scrutiny, as the DFPI aims to establish consistency across all forms of commercial finance, ensuring that disclosures are understandable and fair for small businesses seeking funding.
The DFPI’s enforcement is reshaping how funders interact with prospective clients, requiring upfront clarity on costs and terms. Further, the DFPI may conduct audits or require reporting to ensure compliance. For direct funders, it’s essential to align internal operations with these new standards, developing processes that streamline disclosures and ensure all representatives—whether in-house or through referral partners—are properly trained on these new compliance standards.
Core Compliance Requirements and Their Implications
For factoring companies, the primary areas of compliance under the DFPI’s oversight include:
Estimated APR Calculation: Despite being non-traditional for factoring, an estimated APR calculation must be presented to meet the DFPI’s disclosure requirements. This forces factoring companies to adopt new methodologies to estimate an APR-like figure that aligns with the discounted nature of receivables.
Total Cost of Financing: This must include all associated fees and charges, laid out clearly for prospective clients. Direct funders need to disclose costs in full transparency, even if the fees are minor or contingent.
Clear Terms and Repayment Amounts: The total repayment amount, typically straightforward in factoring, must now be disclosed alongside any potential contingencies or variables. Direct funders are advised to break down these terms clearly to avoid ambiguity.
Each of these requirements affects how factoring deals are structured, marketed, and ultimately closed. Direct funders need to develop systems that standardize the way information is presented, making compliance not just a legal exercise but an integral part of their customer service and communication model.
The Impact on Direct Funders and Referral Partners
The new regulations don’t just impact the funders themselves; they also place new demands on brokers and referral partners. Brokers play a critical role in originating deals and setting initial merchant expectations, so ensuring they fully understand and correctly convey the required disclosures is crucial. Miscommunication at the broker level could result in compliance risks and potential fines for the direct funder.
For funders, this means prioritizing training and education for brokers, ensuring they have a firm grasp on the DFPI’s requirements. Many funders are finding it beneficial to create standardized templates or disclosure statements that partners can use to simplify the process. Moreover, direct funders might consider conducting regular audits of their partners’ client interactions to ensure that compliance protocols are consistently followed.
Adapting for the Future: Best Practices for Compliance
Here are several practical steps that direct factoring funders and their partners can take to align with California’s regulatory expectations:
Implement Standardized Disclosure Templates: Develop templates that incorporate all mandatory disclosures, particularly APR, repayment terms, and total costs, ensuring that all representatives—whether in-house or external—use a consistent format.
Educate and Train Referral Partners: Regular training sessions can help partners stay informed on the disclosure requirements and navigate client questions about these changes. Some funders may also consider creating compliance handbooks or online resources specifically for partner use.
Utilize Compliance Software: Investing in software that automates disclosures and manages APR calculations can help reduce manual errors and speed up the compliance process.
Regular Audits: Conducting audits of transactions and client interactions can help identify compliance issues early. This practice also reinforces a culture of accountability within the organization and across partner networks.
Engage Legal and Compliance Experts: Bringing in legal experts to periodically review compliance procedures is essential, as the DFPI may issue updates or clarify requirements over time.
Conclusion: Navigating the Path Forward in Factoring Compliance
California’s disclosure law marks a new chapter in commercial financing regulation, bringing both challenges and opportunities for direct factoring funders and their partners. While compliance requires upfront effort and adjustment, it also presents an opportunity to set a higher standard in client communication and transparency. Direct funders who invest in robust compliance protocols, partner education, and client-centered transparency stand to gain a competitive edge in a market where trust is paramount.
As the DFPI continues its oversight and more states consider similar laws, the factoring industry must remain agile and proactive. By keeping compliance at the forefront, factoring funders and their partners can not only meet regulatory requirements but also enhance their reputation and relationships with clients.