Businesses have many financing options available to them, and B2B companies often take advantage of unpaid customer invoices to get cash through invoice factoring. As with most other types of funding, there are factoring options that should be understood and weighed carefully to secure the best solution for a business’s needs. Recourse, or liability for unpaid invoices, is a choice that can impact the initial costs of invoice factoring and have considerable consequences down the line.
How Invoice Factoring Works
Invoice factoring is a means to acquire cash for outstanding invoices by selling them to a factoring company, or a factor, in exchange for service fees. The factor advances the money, retaining about 10-30% of the invoice value to account for adjustments and fees, and collects the debts from the customers.
After the invoices have been paid, the factor forwards any remaining balance to the seller. The question to be addressed here is, “What will happen if the factoring company is unable to collect on an invoice?”
Non-recourse factoring is a protection plan for sellers that releases them from liability if a customer doesn’t pay an invoice due to insolvency. It is essential to understand precisely what this means: Insolvency is the inability to pay debts, and in the case of non-recourse factoring, this usually also means the customer’s insolvency must be declared, like a bankruptcy.
The agreement also generally specifies a time frame, called a factoring period, after which the factor may require repayment for a sold invoice, insolvency or not. Factoring companies that offer non-recourse plans usually have their definitions and timetables, and it is vital for a business entering into a contract to understand the extent of liability.
If a customer fails to pay a factored invoice under a full-recourse plan, the seller is responsible for repaying the advance to the factor. This reimbursement can include any fees or costs outlined in the contract.
Even though there is no protection available for the non-payment conditions described above, full-recourse factoring is much more common than non-recourse options. Full-recourse carries less risk to factoring companies, so they can offer lower service fees than they would for non-recourse contracts.
The protection of non-recourse factoring can be rather narrow, and it seems most businesses that consider invoice factoring choose to take the risk upon themselves and save money on the fees. However, each company should examine all of the aspects involved as each situation is different, and what is unfavorable to one business could be ideal for another.