What Is a Non-Recourse Factoring Agreement?
Thinking about invoice factoring without recourse for urgent cash flow or for working capital to grow your small business? Well, it may seem like there are a lot of factoring options out there for small business. Yet, all accounts receivable factoring options are not equal. Likewise, factoring companies (also known as, “factors”) are not all the same. Many factoring companies only offer factoring “with recourse.” More experienced and long-standing factoring companies offer factoring “without recourse.”
Invoice factoring without recourse or non-recourse factoring is an agreement within a factoring contract where the factors client does not have to pay back the factoring company if an invoice is not specifically paid due to bankruptcy of the client’s customer (the Account Debtor) under an invoice with credit protection in place.
With a recourse arrangement, when purchased accounts are not collected by the factor for any reason within a relatively short time, the factor has recourse to charge back to the client the net value of an unpaid invoice. When your company enters into a non-recourse factoring agreement however, your business is protected against extreme situations that prevent your customers from paying an invoice.
Whether a factor offers your company invoice factoring with recourse depends on:
- your factor provides a credit protection program to offset when your customers are unable to pay an invoice due to an unlikely and extreme event, such as, bankruptcy,
- you choose an established factor that is able to spread its risk among many of its clients,
- the credit-worthiness of your customers, and
- your company’s successful application for factoring financing.
A typical non-recourse factoring agreement offers the following basic features:
- Your factor purchases your accounts receivable by paying an advance to your company for up to 90% of the value of each invoice included in your factoring agreement.
- Your factor then promises to pay your company the difference due for the invoice (once your customer pays the factor for the full value of the invoice) minus factoring fees.
- The difference due paid by your factor minus the factoring fees, is paid in a timely fashion to your company as each invoice is paid in full by your customer and according to terms in your factoring agreement including non-recourse assurances.
How Does AR Factoring Without Recourse Help Your Small Business?
First of all, factoring is the purchase of a company’s accounts receivable as opposed to a loan that creates debt on your business balance sheet. You speed up your cash flow by leveraging, or selling-off, the accounts receivable assets your company already has on its books. Factoring focuses on the creditworthiness of your customers, while bank loan departments would focus on your company’s financial history and cash flow. Accounts receivable funding is not a loan. So, your company ends up with less balance sheet debt.
A well-established factor providing AR factoring without recourse helps your small business by:
- providing a master credit policy against the unlikely instance of your customer’s (the “account debtor”) bankruptcy,
- outsourcing the responsibilities and operational costs of receivables collections and credit assessment, and
- not only outsourcing your credit department to the factor, but also outsourcing the risk of accounts receivable!
Which Businesses Benefit from Invoice Factoring Without Recourse?
Many different lines of business benefit from invoice factoring, sometimes also referred to as discount factoring. Some people refer to invoice factoring as discount factoring when the factor purchasing an invoice from its client charges a factoring fee, and then the client thinks of the factoring fee as an amount discounted against the full value of the invoice otherwise to be paid by the client’s customer. Companies that do very well when taking advantage of invoice factoring without recourse include:
- startups with an already established queue of backorders,
- companies with accounts receivable consisting of credit-worthy customers,
- businesses looking for competitive finance rates, and
- fast growing companies with sales of $25,000 – $3,000,000 per month.
As well, companies that leverage invoice factoring without recourse also include industries and businesses facing:
- bank turndowns,
- bank exiting or underperforming banking relationships,
- volatile cash flow,
- funding is required to maintain substantial inventory or materials for production,
- long-duration sales cycles,
- slow paying customers, such as, large corporate buyers or government agencies,
- seasonal sales,
- unanticipated or urgent customer demand for products or services,
- timely opportunities to expand into emerging markets,
- innovations that present a chance to invest in new technology and equipment, or
- options to expand offices, production workspace, or inventory warehousing.
What Is the Cost of Non-Recourse Factoring?
Are there differences in cost between recourse and non-recourse factoring? Many factors without a strong portfolio of clients will charge higher fees for non-recourse factoring than they will for recourse factoring in order to offset their costs for taking a bigger risk with non-recourse factoring. While a factoring company with a deep and solid portfolio, provides the value of non-recourse without passing-on any additional cost to the client. Computing invoice factoring rates using an online Invoice Factoring Calculator provided by a factor that includes Credit Protection & AR Management in the factor’s accounts receivable financing gives you a view of the costs associated with non-recourse invoice factoring.
To use the calculator, you will need to be able to answer the following questions about your receivable accounts:
- Your Estimated B2B & B2G Sales per Month
- Your Current Total Accounts Receivable
- Unpaid Invoices the Last 5 years
- Your DSO, Days Sales Outstanding (How Long Customers Take to Pay You)
How Does a Small Business Apply for a Non-Recourse Factoring Line of Credit?
Another way of looking at invoice factoring is to look at how the typical non-recourse factoring agreement works with a credible established factoring company:
- Your factor’s purchase of an invoice is actually the paying of an advance to your company for of up to 90% of each invoice of your accounts receivable included in the factoring agreement.
- Since this purchase by advance scenario is leveraging your accounts receivable like an asset, you can think of it as using the assets on your company books to secure financing for ongoing business operations.
- A maximum amount of funds available to be advanced will be determined, called your “initial factoring line;” that’s like a line of credit.
- Your factor then promises to pay your company the difference due for the invoice once your customer pays the factor for the full value of the invoice, minus factoring fees according to terms in your factoring agreement including non-recourse assurances and credit protection.
Much like you would expect when applying for a typical secured line of credit, it makes sense for a small business to apply for non-recourse factoring financing by completing the following steps:
- Complete a short application.
- Supply your company’s most recent accounts receivable and accounts payable aging reports.
- Present your articles of incorporation.
- Provide a master customer list.
- Supply a sample invoice.