Factoring companies can offer two kinds of invoice factoring: non recourse factoring and recourse factoring. Most companies offer only recourse factoring; a very few companies offer only non-recourse factoring; and some offer both recourse and non-recourse factoring.
In recourse factoring, the factoring company does not assume the financial risk for non-payment. If a client’s customer does not pay on their invoice within 90 days or 120 days or whatever timeframe is set in the factoring agreement, the factoring company collects back the amount of the advance from the client. The client assumes the financial risk for non-paying customers.
In non-recourse factoring, the non-recourse factoring company pays its client an advance on a customer’s invoice, even if the customer does not pay. The factoring company becomes responsible for collecting on that invoice and takes on the financial risk for non-paying customers. In the event that a customer never sends payment in for their bill, nonrecourse factoring companies will not expect their customers to reimburse them any part of the advance on the invoice that they received. Because of the greater risk for loss, non recourse factoring companies can charge higher factoring rates and set specific limits.
What is Non-Recourse Factoring?
In the case of the tea merchant, since the factor was advancing funds to the merchant and was receiving a factoring commission from the tea merchant to vouch for the American buyer, the merchant had no risk in the transaction if the American distributor turned out to be unable to pay for the goods. The factoring company lost whatever it advanced to the seller. This became known as non-recourse factoring.
For the first 200 years, factoring companies stuck with industries they knew best: apparel, dry goods, textiles and furniture. By concentrating in the eastern United States and sticking with known industries, they could continue to collect fees for their expertise in vouching for the creditworthiness of their clients’ customers.
What is Recourse Factoring?
In the late 20th century, entrepreneurial factoring companies entered the scene, offering most of the services of the old-line factors, minus the voucher for the buyer. In this stage of factoring evolution, the factoring company became more a financial institution than a trade merchant. Fewer and fewer factoring companies offered non-recourse factoring because the risks were simply too great and the rewards too minimal. Hence, “recourse factoring” – also known as “full-recourse factoring” or “factoring with recourse” – was born.
Non-Recourse vs Recourse Factoring
Today, some factoring companies advertise nonrecourse factoring as a gimmick to attract recourse factoring business. Very few companies offer true non-recourse factoring arrangements. Agreements can be cleverly drawn so that many loopholes exist, loopholes that allow the factoring company to revert to the seller any invoice, whether it was purchased on a non-recourse or full-recourse basis. Often, the client is sold a supposed non-recourse factoring arrangement, but none of the invoices that the client sells to the factor “qualify” for factoring non recourse treatment. A side agreement is then made to allow the factor to buy certain receivables on a full-recourse basis and others on a supposedly non-recourse basis.
In any event, many of the risks of non-payment are never fully transferred from clients to “non-recourse factoring companies” regardless of how the transaction is defined. For example, if there is any dispute (real or imagined) between seller and buyer, the factoring company can specify that its client is responsible for the invoice. If the client or the client’s customer is in breach of any part of the factoring agreement, any invoice factored during such breach may be put back to the client to reimburse the advance that it received. As a result, there are very few true non recourse factoring companies operating in today’s marketplace. However, this wasn’t always the case.
Benefits of Non-Recourse Factoring
Non-recourse factoring agreements bring the same benefits of recourse factoring, plus some additional benefits applicable only to non-recourse factoring.
- Instant working capital. Keep you company running smoothly with advances on your accounts receivable sent to you on the same day you submit your invoice to the factoring company.
- Easy qualification. Your eligibility depends on your customers’ creditworthiness, not your past payment history or credit score.
- Fast processing. Top-tier factoring companies can often get you started within a few days after you submit your application and paperwork.
- Protection from customers’ nonpayment for credit reasons. You are protected against business loss if your customer goes bankrupt and cannot pay you. The factoring company will not require you to pay back the advance when the non-paying customer has a legitimate credit problem. However, if the customer’s nonpayment arises out of dissatisfaction with your work or a disagreement, you will still be required to pay back the advance.
The key benefit for non-recourse factoring is that last one. Different factoring companies will have different requirements for what constitutes credit reasons for nonpayments, but having the factoring company absorb the loss when a customer defaults on bills is an important difference between the two types of factoring.
History of Non-Recourse and Recourse Factoring
To better understand no recourse factoring, imagine you are a tea merchant in Southampton, England, 300 years ago. The colonies in America are a sovereign nation and the British continue to emigrate to the United States, fueling a strong demand for English tea. You want to sell your tea to distributors in the new country, but this is a tremendous risk. You need to fill a boat with crates of tea, sail it to America, unload your tea in Boston Harbor, and then hope that you receive payment from the American distributor at some future date.
In those days, merchants in the old country had to rely on a network of trusted people who could vouch for the creditworthiness and trustworthiness of customers in the new country. In some instances, the trusted people themselves became trade merchants. They could not only would vouch for the buyer, but would also take the risk of non-payment out of the transaction by either fronting the cash to the seller in England or by actually taking possession of the goods, paying the English merchant, retitling the goods, and selling them to the ultimate buyer. Credit may or may not have been part of the final transaction.
These early trade merchants were the first known factors. As business practices evolved, so too did the factoring industry. Eventually, factoring companies began not only vouching for the buyer of the goods and advancing a small portion of the hoped-for revenue to their client, but also collecting the sales proceeds directly from the client’s customer. They would then pass on the rest of what they collected to their clients, minus a factoring commission.
What is Modified Non-Recourse Factoring?
Recently, the concept of “modified non-recourse factoring” has evolved. The term usually refers to a factoring transaction in which the factor will assume the “credit risk” of their client’s customer for a limited time after the factored invoice becomes due. In most factoring agreements, “credit risk” means the bankruptcy of the customer. In a modified non-recourse arrangement, the factoring company is essentially vouching for the client’s customer up to a point.
For example, a typical modified non-recourse arrangement protects the client selling the invoices from any potential customer’s bankruptcy filings for a period of 60 days after the due date of the invoice. If there is a bankruptcy filing by the customer between the date the invoice is factored and this prescribed period, the factor takes the hit. For a typical factoring company non recourse factoring is not a viable business option. If for any other reason the invoice is not paid by the client’s customer (after the prescribed period), the factor puts the invoice back to the client and the client takes the hit.
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