Factoring benefits your business in two important ways. First, factoring advances money on your accounts receivable and helps you build up cash flow. Secondly, a factoring company collects payment on those receivables from your customers. Having more cash on hand and a factor that handles collections gives you more time and money to run your company.
But what happens if a customer does not pay one of your invoices? That is where the differences in “recourse” versus “non-recourse” factoring come into play.
Two Ways to Factor
Recourse factoring, the most common type, means that your company must buy back any invoices that the factor is unable to collect payment on. You are responsible for any invoices your customers do not pay.
With non-recourse factoring, the factor accepts more of the risk of non-payment by your customers.In specific situations, outlined in the non-recourse agreement, you may not be responsible for unpaid invoices.
Non-recourse factoring can sound appealing from a risk-management perspective. However, not all factoring companies take on non-recourse accounts. Those that do offer non-recourse factoring usually include several stipulations. Non-recourse factoring is more expensive, often by as much as a full percentage point. For example, if a factor charges 2% on invoices funded through recourse factoring, the fee for non-recourse factoring would likely be 3%.
Non-recourse factoring is also limited to invoices with debtors who are most likely to pay. If the debtor has a poor credit rating and payment history, the factor will not assume the risk of non-payment.
Finally, non-recourse factoring does not necessarily protect your company from all risk of non-payment. Many factoring companies offer non-recourse that only applies if a debtor declares bankruptcy. So if a debtor just closes its doors or simply disappears without payment, the factoring customer must still buy back that invoice from the factor.
Whether your company plans to pursue recourse or non-recourse factoring, it is important to sit down with a reputable factoring company to discuss their terms. It may be to your advantage to find a factor that offers both recourse and non-recourse factoring. A factoring company with a strong credit team can also help you avoid working with customers that have poor payment histories.
Regardless of the type of account, a good factor will always make a diligent effort to collect on your invoices. Collection calls from the factor to a debtor should start 40 days after the invoice was sent and continue for several weeks. After 90 days, the factor may “recourse” the invoice back to you. The factor should, however, provide options for helping you cover the cost. The factor may withhold a portion of future cash advances or deduct cash from your reserve account. Working out an unpaid invoice should not cause your company financial hardship as it isn't in the best interest for you or your factor.
For more tips on choosing the right factor, read our article, “Important Questions to Ask a Factoring Company.”
The best-case scenario is for your company to have customers with good credit and solid payment histories. This enables you to pay lower fees for recourse factoring without worrying about the risk.