Knowing the difference before making an investment
Businesses looking for quick access to cash flow generally turn to factoring their invoices. Factoring is often defined as the selling of a companies account receivables at a discount to a Factoring Company who assumes the risk of the account debtors. As the debtors are settling their accounts, the factoring company will then receive payments until all the outstanding invoices have been paid. The debtor is also required to pay a transaction fee to the factor regardless if all invoice payments have been collected.
There are two options to consider when choosing a Factoring Financing: Recourse and Non-Recourse factoring.
Recourse: Recourse Factoring is when a company sells it’s invoices to a factor, with the promise that the company will buy back any uncollected invoices. The factor does not take the risk of any uncollected invoices. 90% of factors are recourse to avoid the high risk of unpaid accounts.
Recourse Factoring provides more of an advantage for Lenders because the lender is capable of going after the borrower, if any of the clients account debtors defaults. There is less risk involved for the lender, and more for the applicant since they are on the hook on any uncollected payments.
On the other hand from a borrowers perspective, recourse factoring is more affordable, but requires the company to absorb the risk of any uncollected invoices. If your company is looking to factor and you have good solid account debtors then recourse factoring might be a better option for you.
Non-Recourse: First things first, Non- Recourse is NOT A LOAN, it is more closely referred to as a secured debt of collateral.
In Non-Recourse factoring, a company sells their accounts receivable to a factor, whom then supplies the cash needed to cover the invoices. The difference with non-recourse as opposed to recourse factoring is that the company has no liability with any uncollected invoices. The factor absorbs all the risk. Because non-recourse cold be a higher risk for lenders, the transaction fee sometimes could be higher.
From a lender’s perspective, Non-Recourse is a high-risk transaction. The main reason for the high-risk is the possibility of fraud. Fraud is easily the biggest risk to any factoring lenders, which is why factors take a great deal of time to research a business and how credit worthy their customers are before providing them with non-recourse factoring.
Non-recourse factoring is usually more expensive for businesses because the lenders are the ones who are assuming all the liability. Most invoice factoring companies charge between .5% and 1% more for non-recourse factoring.
This can be a more appealing approach to borrowers because they do not hold the risk of losing everything they own except the collateral they initially put on the loan.
The other advantage of Non-Recourse factoring could also be that fact that it acts like credit insurance for your business. Credit insurance (which insures receivables if they go bad) is really only feasible and available to very large companies. That is because it is expensive and not affordable to the small business doing $10 Million or less in gross revenue. So non-recourse factoring acts like credit insurance in that if any account debtor goes bad or does not pay, you can sleep well at night knowing that you don’t have to pay back the factor so long as there is no fraud involved. The business essentially “insured their receivables when they factored them with a non-recourse factoring lender.
Learn more about Durham’s Factoring Here