So you’ve factored your invoices to improve your cash flow, but come to find out that one of your customers isn’t able to pay. Are you now liable for their outstanding debt?

The answer depends if your factoring agreement is recourse or non-recourse.

What is Invoice Factoring?

Invoice factoring is where a company sells the value of outstanding invoices to a third-party company called a factor. The factor pays the company in two installments.

The first installment is a lump-sum advance paid to the company when the invoices are factored. The advance installment will be a large portion of the total value – usually 70% to 95%.

The factor assumes responsibility for collecting the invoice payments from customers. When customers pay invoices, the factor takes a small finance fee and then pays the remaining amount to the company. The second installment is often called a rebate.

Recourse vs Non-Recourse Factoring

To illustrate the difference between recourse and non-recourse factoring, let’s say that one of customers in the example above declared bankruptcy during the factoring period and cannot pay their invoice. 

A recourse factoring agreement requires the company to buy back the invoice. Depending on the agreement, the factor could give 60 to 120 days to pay back the debt. If cash is unavailable, the company would need to provide a new invoice of equal or greater value as collateral.

With a non-recourse factoring agreement, the company does not have to pay back the factor for the defaulted invoice amount. Non-recourse factoring only offers default protection for the advance installment, not the rebate, so the company would still incur a partial loss.

Which Is Better?

Focus on getting the maximum advance with the lowest factoring rate (use our Dollar Cost Calculator). This will provide you with the most cash — for the lowest cost.

If competing factor companies are offering the same rates, but one offers non-recourse, go for the extra protection.

Approximately 80% of all factoring companies offer recourse agreements. Recourse may have a lower factoring rate than non-recourse because of the reduced risk for the factor.

Non-recourse offers lower risk to the company, but it’s not entirely risk free. Although non-recourse offers more protection, there are many instances where you are still liable for non-payment. See more below about qualifying credit events.

Factors assess the credit of every invoice, and their rates will reflect the risk. If your company can break even on the advance rate, non-recourse could be a safe option since the rebate installments will be all profit.

Benefits of Invoice Factoring

Provides Working Capital

For a small fee, invoice factoring gives your business a cash advance on future payments. You can use this cash to pay expenses or invest in growth.

Compared to alternative financing options, invoice factoring offers very competitive rates. There are at least 50 factoring companies competing nationwide, which helps to keep the rates low.

Your Credit Score Doesn’t Matter (Much)

Your credit history is one of the least important factors for determining your eligibility for invoice factoring. If you have bad credit, it could mean a slight rate increase, but it will not make a huge difference.

Your customers’ credit and invoice value matter a lot more.

Helps You Avoid Credit Risk Clients

It is difficult for a small business accounting team to do thorough credit checks on every client. A factor can help provide guidance on prospective customers and their likelihood of default.

If they determine a client has bad credit, you can ask them to pay in advance to limit your exposure.

Downsides of Invoice Factoring

Credit Limits

Your customers must have good commercial credit to qualify for invoice factoring.

It’s less of a concern for recourse agreements, but factor having faith your customers will pay is the foundation of every transaction.

Non-Recourse Credit Events

Most non-recourse agreements narrowly define insolvency as a declared bankruptcy during the factoring period. Some factoring companies have broader terms that cover default for any credit event.

There are no set industry standards, so pay attention to the details before you sign an agreement.

It’s worth mentioning that a non-recourse invoice factoring agreement does not offer protection against customer disputes or late payments. You would still be liable, for example, if your customer:

  • Cancels an unfulfilled order
  • Delays a payment while resolving a product quality dispute
  • Is unhappy with the service you provided and decides not to pay
  • Disputes the invoice and pays a lesser amount

Remember that factoring is about shortening the gap in receivables to improve cash flow on good debt. While non-recourse factoring provides some additional protection, it is not the same as accounts receivable insurance.

Final Thoughts on Non-Recourse Factoring

There are times you might need the most cash possible – and that’s ok – even if it means not taking the lowest rate. And if you’re in a rush to get cash, keep in mind that recourse factoring is quicker to get set up because of less stringent credit checks.

Invoice factoring remains one of the most popular and affordable methods of business financing. As you review providers and proposals, pay attention to the advance rate and per dollar cost of each. If competing factor companies are offering similar dollar cost, but one offers non-recourse, go for the extra protection.

Now that you understand how invoice factoring works, use a directory of factoring companies to find providers that can help you free up your cash flow.

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