The Differences Between Recourse And Non-Recourse Invoice Factoring
Non-recourse factoring is a highly sought-after option when you’re considering a new invoice factoring partner. Because this form of factoring can save you money if your customers don’t pay their invoices, it sounds like a good deal.
Unfortunately, there are many misconceptions about this kind of factoring, and some factoring companies are not entirely invested in clearing up these misconceptions. To ensure you’re getting the best arrangement for your business, you need to know the benefits and limitations of non-recourse factoring.
So what is non-recourse factoring? How does it differ from recourse factoring? And is non-recourse factoring right for your business? Keep reading to find out!
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Invoice Factoring Basics
At its core, invoice factoring is straightforward. A business sells its invoices to factoring companies (also called factors) at a discount in exchange for immediate cash. This enables the business to function normally without worrying about how long a client takes to pay.
Numerous businesses in the B2B sector utilize factoring. Industries that frequently use factoring include transportation, government contractors, staffing companies, advertisers and media companies, and pretty much any other business that invoices customers.
Put plainly, plenty of merchants employ factoring to smooth out their financials. If cash flow problems impact your business operations because your clients take their sweet time paying invoices, factoring might be an option worth looking at.
How Recourse Factoring Works
In this instance, recourse means “the legal right to demand compensation or payment.” In the case of invoice factoring, a recourse agreement means that you are responsible for repurchasing the invoice if your customer does not pay for any reason.
A good invoice factor will not leave you high and dry, though. After all, the primary function of invoice factoring is to solve cash flow problems, and nothing kills your cash flow like unexpectedly having to repurchase a bad invoice.
Here are some common ways merchants can pick up the cost:
- Replace the unpaid invoice with a good invoice of similar value
- Pay using the reserve (the percentage of every invoice that is withheld for fees)
- Pay in installments
Recourse factoring is the most common type of invoice factoring on offer these days. However, it’s not difficult to find an invoice factor that uses non-recourse services in some form or another.
How Non-Recourse Factoring Works
As you might expect, non-recourse factoring means that your invoice factor cannot take recourse if your customer doesn’t pay. In other words, the invoice factor has to absorb the loss for invoices left unpaid.
In the past, invoice factoring was completely non-recourse. The invoice factor always had to absorb the loss for any unpaid invoices (except disputed invoices). However, these days, invoices covered under non-recourse are not quite so cut and dry.
To differentiate the new method from traditional non-recourse factoring, some companies refer to it as “modified non-recourse factoring.” Regardless of the terminology, almost every factor that offers non-recourse services is referring to this type of service: non-recourse factoring through credit protection.
In other words, you do not have to repurchase the invoice if your customer declares bankruptcy.
On the other hand, the factor will not cover the lost capital that results from disputed invoices. If your customer does not think that you fulfilled the order and will not pay, you will be held responsible.
Invoices that are unpaid or paid late due to forgetful, disorganized, or slow-moving customers are typically not covered under non-recourse factoring as well. However, a good invoice factor will work with you or your customer to solve the problem before charging the invoice back to you. Additionally, finding an invoice factor which takes on collection services for your business can mitigate the risk of slow or late payments.
Although non-recourse factoring offers benefits in the event of non-payment, there are a few drawbacks to this service. Because of the additional risk to the factoring company, non-recourse tends to be more expensive than its recourse counterpart. Additionally, a non-recourse factor may not be willing to purchase invoices for customers they cannot get credit protection on.
Which Is Better For Your Business?
While non-recourse factoring seems like a good thing, that isn’t always the case. This is especially true because non-recourse options usually cost more and have limited application.
You should choose non-recourse factoring when:
- The upfront fees are worth paying for because you have clients that might dissolve their assets
- You won’t be able to bear the costs if a client dissolves
You should choose recourse factoring when:
- You can’t afford the upfront fees
- It’s unlikely your clients will dissolve
- You’ll be able to bear the costs if a client does dissolve
Non-recourse factoring may offer you more protection. However, because the definition is changeable, it’s crucial to understand what is and is not covered under a “non-recourse” agreement before settling on a factor. On top of that, non-recourse factoring is rarely worth the initial fees.
So while non-recourse factoring sounds snazzy right off the bat, you may find it cheaper to go the normal recourse route. Ultimately, it’s perhaps most important to find a factor that adequately communicates with you in the event of non-payment, so you can solve problems before they become urgent.
Ready to find an invoice factoring partner for your business? Merchant Maverick has a whole slew of ways to find your factoring partner. Take a peek at our full list of reviews to see which ones have non-recourse agreements and which ones don’t. You can also check out the comparison of our favorite factors.