Even today, not everyone is familiar with how factoring works. It’s becoming much more popular now since banks have become quite recalcitrant in approving small business loans, but still, there are business owners who don’t understand how they can benefit from factoring. Even those who are already aware of factoring may still not be fully aware of how non-recourse factoring is different.
This is how factoring commonly works: you use your accounts receivable to get the funding you need. The factoring company “buys” receivables from you and in exchange you get an advance on the value of the invoice instead of waiting for 30 days for your customers to pay you in full. The customers then send the payment to the factoring company directly, who in turn will send you the rest of the payment owed to you, minus their fees.
The percentage of the advance depends on the factoring company, and how creditworthy your customers are. On average, a top factoring company may offer up to 80% of the value of the invoice and charge you a measly 3% of the value. So if the invoice is worth $10,000 then you may get $8,000 right away to use as you will, and when the company pays after 30 days you then get $1,700 because the factoring company takes $300 as fee for its services.
When a Customer Doesn’t Pay
Regular factoring is also referred to as full recourse factoring, because the factor can get back the advance from you if your customer doesn’t or can’t pay the invoice. Usually when the customer pays late, you pay an extra fee. But if the customer doesn’t pay beyond the specified time period in your contract, then you have to give the money back.
Returning the advance may take form in several different ways. Maybe it’s as simple as returning the money. But since you may have already spent it, you may have to offer another invoice as payment and the money is taken from your advance. Some factoring companies even take a portion of the advance payments for the invoices to fund an account that’s specifically meant to cover such a contingency.
Even though the factor can get its advance money back from you, it’s still terribly inconvenient and troublesome when a customer doesn’t pay up. It’s for that reason factoring companies investigate your customers to see that they have a good credit standing.
So What Is Non-Recourse Factoring?
In non-recourse factoring, you don’t have to return the cash advance if the company doesn’t pay. In most cases, a “modified” non-recourse factoring agreement is in place. This usually means that you don’t have to return the advance if the customer suddenly becomes bankrupt. However, because the factoring company takes a bigger risk, the fees may be greater and the advance may be less.
Theoretically, your non-recourse factoring options may also include a full non-recourse agreement. Here, you won’t have to return the money if the customer doesn’t pay for any reason whatsoever. This type of factoring is so rare that it is almost non-existent, and the fees can be truly high if it is ever offered.
What all these means is that you have to really understand what your agreement with your factor entails. Whether you use non-recourse factoring or not, you have to know the exact terms of your agreement so you know what to expect in case a customer does not meet their financial obligations to you.