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Many small businesses are familiar with the concept of factoring. This is a funding method in which you get a cash advance that’s normally 70-80% of the value of the invoice, and when the customer pays in full you get the rest of your money once the factor has taken its fees from the payment. Normally, you’d have to return the cash advance if the customer doesn’t pay, but that may not be the case in non-recourse factoring.
The Specific Definition of Non-Recourse Factoring
Each factor has its own definition of non-recourse factoring. Now it may be a perfect situation for you if the factor accepts all the risk of nonpayment, but that is almost always never the case. This isn’t a time when you tell your factor about “buyers beware”. Usually, part of your agreement with the factor is a clause requiring you to buy back the invoice from the factor when payment isn’t made.
Almost always, the definition of non-recourse factoring involves only nonpayment due to insolvency. Now here again the term “insolvency” needs to be defined clearly in the agreement with your factor. Some factors have different definitions, so you have to be on the same page.
This clearly means that if the customer declines to pay you because of a payment dispute or a disagreement regarding the quality of the goods you were supposed to deliver, the factor doesn’t assume the bad debt. Instead, you’ll be required to return the money you received as a cash advance.
Time Periods for Payment
Usually, even in non-recourse factoring there’s a time period within which the customer must make their payment in full. Most of the time, this is anywhere from 60 to 90 days. But some factoring agreements call for a return of the cash advance in just 45 days, while other factors even offer up to 180 days. This is one of the non recourse factoring options you may want to negotiate with your factor.
If the customer doesn’t pay for any reason other than insolvency, then the factor can recourse or ask you to buy the invoice back. This is rarely the matter of returning the money in cash. Most of the time, you’d have spent that money already.
But the factor can ask that you submit another invoice for them in exchange, and they can get the payment for the earlier cash advance from the new invoice when that new customer pays in full (and meanwhile you don’t get a cash advance from that new invoice).
Another option is to get the money back from the reserve accounts (the money not part of the cash advance). This is the money held back by the factor for this very purpose.
Non-recourse factoring is more expensive than conventional factoring, but clearly you need to know the details and definitions of their service. Take note of the non recourse factoring options, but the first thing you need to do is to determine if this type of factoring actually serves your needs.