Non-recourse factoring is a type factoring financing in which the factoring company assumes the loss if invoices are not paid due to end customer insolvency. It is one of the two common types of invoice factoring offered by finance companies. However, it is also widely misunderstood by clients. In this article, we discuss:
- How does factoring work?
- What is non-recourse factoring?
- How are payment disputes handled?
- How are unpaid invoices handled?
- Advantages and disadvantages
- Why type of factoring is better?
1. How does factoring work?
Factoring companies help clients by financing their accounts receivable. Most factors fund receivables by purchasing them, rather than lending money to the client.
Most transactions have a simple structure. The factoring company buys the financial rights to its client’s invoices and pays for them in two installments. These quick payments provide the clients with funds.
A transaction ends when the customer pays the invoice in full, on their usual schedule. Accounts settle at that point, and the sale of the receivables concludes.
This description leaves an important question open. What happens if the customer does not pay the invoice? The answer depends on why the customer did not pay and if you are using non-recourse factoring.
2. What is non-recourse factoring?
Non-recourse factoring transactions are structured just like conventional transactions. The only difference is what happens if your customer does not pay (under specific scenarios).
If you have a non-recourse factoring agreement, the factoring company absorbs the loss of non-payment due to insolvency by the customer during the factoring period. There are some essential details in that definition that are often misunderstood.
Most non-recourse agreements absorb losses only if the non-payment happens due to insolvency. In this context, insolvency usually means bankruptcy – such as Chapter 11. Bankruptcies are formal legal processes that have to be declared.
Furthermore, the bankruptcy must happen during the factoring period. This period starts when the factor buys the invoice and ends 90 days later.
Although the protections provided by non-recourse factoring are valuable, they are also very narrow. Keep in mind that some factors have more flexible definitions of insolvency than others. Some may absorb a loss if the customer closes their doors without declaring bankruptcy.
3. How are payment disputes handled?
Many people mistakenly believe that non-recourse factors absorb losses from payment disputes. No factoring company – regardless of recourse – absorbs the loss for disputes.
In the event of a dispute, the factor returns the invoices that are disputed by your customer. You must return the advance and pay the fees of the factor. Your company can do this by either replacing the invoice, having the factor debit the reserve, or by wiring funds.
It is always in your best interest to deal with disputes directly rather than rely on a factor. This approach ensures your client is appropriately served by you and ensures you keep your reputation.
4. What if your client decides not to pay?
There are times when clients in good financial health decide to pay slowly or not at all. While unfortunate, this happens every so often. Most commercial credit searches should identify these types of clients early on. A good factoring company helps you avoid them altogether.
Unfortunately, most non-recourse factors do not absorb a loss from this type of non-payment. Your company must repay the factor for the advance and unearned fees.
5. Advantages and disadvantages
In general, non-recourse factoring plans have the same advantages and disadvantages of regular factoring programs. There are a few differences, though.
The main advantage of non-recourse plans is that they protect you against customer insolvencies. Most factors’ credit reviews catch financially shaky customers early on. However, the process is not perfect. A non-recourse plan adds a valuable layer of protection. However, non-recourse plans have some disadvantages over full-recourse factoring plans. These disadvantages include:
- Programs may be slightly more expensive
- Fewer customers may be approved for factoring
- Credit lines may be smaller
- Factors monitor the portfolio very carefully
6. Which type of factoring is better?
In general, both full- and non-recourse factoring plans perform about the same. Therefore, you need to balance each program’s benefits and disadvantages against your needs.
Non-recourse plans have a slight advantage because they provide some protection against surprise customer insolvencies. While rare, these types of bankruptcies still happen.
7. Are you looking for a factoring company?
If you are evaluating factoring companies, consider reading our guide on “How to Choose the Best Factoring Company for Your Business.” It has a downloadable evaluation tool that helps you in your decision-making process.
Get more information
We are a leading factoring company and can provide you with a non-recourse factoring quote with high advances and low rates. For more information, call (877) 300 3258.