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 type of 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 the event of non-payment, the business takes full responsibility for paying back the borrowed amount. You can choose recourse factoring to save money, but you have to make sure your clients have a great 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 huge problem for your cash flow, especially if you’re still trying to break even. In cases like these, you’ll 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 businesses using invoice factoring 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 won’t have to. Instead, you can focus more on running your business efficiently rather 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. But, 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.
Should You Go With Factoring with Recourse or Non-Recourse?
The industry you are associated with may influence your choice between non-recourse and recourse factoring. For example, it’s generally understood that a majority of 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 that can 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’ll also get the chance to pay lower fees associated with invoice factoring.