If you’re brand new to factoring, like a large percentage of our applicants and it hasn’t occurred to you yet, I promise you’re going to want to know the answer to the two following questions
- What happens when one of your customers can’t pay on an invoice you’ve sold to a factoring company?
- What happens when your customer won’t pay an invoice you’ve sold to a factoring company?
The good news is that the answer to both of those questions is probably the same. Your factoring agreement will dictate the terms surrounding such an instance and those terms are largely dependent on which type of facility you have in place. Is your factoring facility a recourse factoring facility or a non-recourse facility? While some companies provide both types of arrangements a large number of companies are simply recourse or non-recourse across the board and will gladly inform you which category they fall into.
- Basic knowledge about factoring might lead you to believe that you’ve sold your invoice to a factoring company and they’ve assumed all of the liability for non-payment by your customer, meaning there’s no penalty or chargeback in the event of non-payment.
- You might assume that pricing and advance rates are fairly equal across recourse factoring companies and non-recourse factoring companies.
- One could be misled to believe that both factors providing non-recourse factoring facilities and factors providing recourse factoring facilities are going to allow you to factor all invoices for the customers of your choosing.
My best advice - don’t make any assumptions. Blogs like this one are a great source of information and can probably answer all of your general questions about factoring, but there’s no substitute for research, asking questions, and carefully reading term sheets. I suggest you be cautious in your vetting process and look for exceptional customer service. Typically, a quality company which provides value in the long run is going to be marked by their service and honesty throughout the process. After you’ve chosen to invest your time going through the application process you should painstakingly read your term agreement and be sure to ask any questions that you might have before signing any documents. A factor with integrity and long term mutually-beneficial relationships in mind will welcome your desire to fully understand both processes and associated fees. Likewise, a company which cannot or will not clarify pricing in a reasonable manner is probably not the partner you are looking for.
Recourse factoring, also known as discount factoring, is typically less costly than non-recourse factoring. If you’re in the comparison process and finding this not to be true that should be a red flag. This doesn’t mean you shouldn’t do business with a company who is at the high end of a reasonable spectrum. After all, sometimes you get what you pay for. However, because the factor assumes less risk in a recourse factoring agreement you are generally going to benefit from lower fees and higher advance rates than that of a non-recourse factoring agreement. These higher payouts provide you with more money for purchases or operating costs which can also translate to higher confidence to take on larger projects and PO’s.
Despite assuming less risk in their agreements, recourse factors also provide in-depth customer screening to the benefit of their clients. Multiple business credit searches revealing payment experiences, average accounts payable balances, and highest balance information are just one facet of this screening process which provides underwriters the ability to make educated decisions about which of your customers have an acceptable risk rating. When leveraged properly your factor is a valuable asset who will gladly help you consider whether or not to do business with a potential customer. However, you should expect that all of your customers may not be deemed acceptable to the factor. When working with a non-recourse factor you may find them to be even more restrictive in the customers they allow you to factor invoices for.
Non-recourse factoring, also known as traditional factoring, can be said to have its own protections built in for the factor. While generally speaking the client has passed on all the risk of non-payment, and pays a higher price to avoid chargebacks on unpaid invoices, the occurrence of non-payment to the factor by one of your customers is usually not without consequence. Much like an insurance company obligated to payout on a policy due to some accident or natural disaster may be able to invoke certain clauses within the policy terms allowing them to raise your premium or re-evaluate your relationship, a non-recourse factor will have clauses in their agreement allowing for adjustments to your relationship after an event of non-payment by one of your customers.
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