Invoice factoring is great for businesses looking to cover payroll, invest in inventory, or pay daily business expenses. With factoring, businesses can sell their pending invoices to a third-party company (factor/lenders) in exchange for 80% to 90% of the invoice value. Typically, the transaction fee would be deducted once all the customers’ invoices have been paid.
Businesses use invoice factoring for a variety of reasons. A lot of business usually has to wait a couple of weeks before they get paid. Without cash on hand, they won’t be able to pay for their day to day business needs which can result in inefficiency. With invoice factoring, however, companies can sell their invoices in exchange for cash up-front. This helps stabilize the business cash flow allowing owners to pay for their day to day operations and other investments.
Invoice factoring comes in two types: recourse and non-recourse. However, people who have little experience in business loans could easily get confused with the different terminologies and concepts. If you’re one of them, you’ve come to the right place.
Recourse Vs. Non-Recourse Factoring: What’s the Difference?
Knowing the difference between these two types is a good starting point in navigating the world of invoice factoring. With that said, here’s how both concepts work:
Full recourse factoring is the most common invoice factoring business owners avail. According to the International Factoring Association, 88% of the invoice financing industry practices recourse factoring.
This type of invoice factoring is relatively cheaper because factoring companies only assume a portion of the invoice value. This means that in non-payment, the business takes full responsibility for paying back the borrowed amount. You can choose to save money, but you have to make sure your clients have an excellent credit history.
Remember, if your clients refuse to pay within the agreed period, the lender can charge in invoices back to you. This creates a massive problem for your cash flow, especially if you are still trying to break even. In cases like these, you will be given three options to resolve the issue:
- You can pay the money back;
- Replace the invoice with another invoice of the same value; or
- Pay the borrowed amount using the reserves.
The good thing about factoring is that lenders will make sure not to leave you dry. After all, their primary purpose is to help your business resolve cash flow issues, not add to it.
According to the Global Funding Resource, over two-thirds of invoice factoring businesses choose non-recourse factoring over recourse financing.
In non-recourse factoring, lenders assume the full responsibility of the invoices – whether it gets paid or not. Once the invoices are sold under non-recourse factoring, you don’t have to deal with those invoices again.
Non-recourse factoring companies are responsible for collecting payments, so you will not have to. Instead, you can focus more on running your business efficiently than chasing customers for payments. Many business owners choose non-recourse financing solely for the benefit of delegating debt collection tasks.
If you lack the time, money, or resources to collect customers’ payments, non-recourse factoring is the best way to go.
Compared to recourse factoring, non-recourse financing is more expensive mainly because the factor assumes 100% of the risk. For instance, a factor may charge 3% on invoices under recourse factoring, while non-recourse factoring fees would be 4%.
In hindsight, non-recourse factoring may sound like the perfect option. Nevertheless, not all factoring companies offer non-recourse factoring. For companies that do offer non-recourse factoring, there are usually multiple stipulations under this type of agreement.
Non-recourse financing is a type of commercial lending that entitles the lender to repayment only from the project’s profits the loan is funding and not from any other assets of the borrower. Such loans are generally secured by collateral. Non-recourse financing entitles the lender to repayment only from the project’s profits which the loan is funding.
Non-recourse financing is a branch of commercial lending characterized by high capital expenditures, distant repayment prospects, and uncertain returns.
Non Recourse Invoice Factoring
If a lender is offering you a factoring or discounting agreement without recourse, they accept entire liability for non-payment of your customers’ debts. This arrangement would be suitable if there is an element of doubt about their ability to pay, either now or in the future.
Non-recourse vs. recourse factoring
Recourse factoring is the most common and means that your company must buy back any invoices that the factoring company is unable to collect payment on. You are ultimately responsible for any non-payment.
Non-recourse factoring means the factoring company assumes most of the risk of non-payment by your customers.
Should You Go With Factoring with Recourse or Non-Recourse?
The industry you are associated with may influence your choice between non-recourse vs. recourse factoring. For example, it has generally been understood that most transportation and freight companies may choose the latter.
To be on the safe side, you can look for factoring companies that offer both types of factoring. Regardless of the type you choose, try speaking with only reputable factoring companies. Then, compare the terms each company offers. Some companies also have a credit team to help you avoid working with customers with bad credit.
Whatever type of invoice factoring you choose, the best way to stay safe is to transact with creditworthy customers. Not only will this help you avoid the risks, but you will also get the chance to pay lower fees associated with invoice factoring.