Factoring is when you sell your invoice to a third-party factor with the intent of having the factor pay you quickly for the invoice (minus the agreed-upon fees). Your invoice is then paid out by your client to the factoring company at a later date. But what happens if your customer defaults or pays in 60 days on the invoice? Who is responsible for the payment? From here the industry is broken down into two categories: recourse and non- recourse factoring. But what is the difference between the two, and does “non-recourse” even really exist? Choosing the wrong one can be a costly decision for your company. Let’s examine:
The more straightforward of the two options is recourse. Recourse factoring is when a factoring company collects from you on an invoice your customer defaulted on. This might sound risky but it is not as perilous as it appears. Good recourse factors usually have several safety nets in place to help ensure your business does not suffer because of a bad customer. TAFS uses the recourse method because being transparent with the client is important. You should be very cautious if a factoring company claims to be a true or full non-recourse, and read the contract or agreement carefully. You always want to know how many days until the factoring company will start to recourse funds, so you can stay on top of your aging.
Credit Check System
The first safety net is a free credit check service. Recourse factors usually offer free credit checks so you can verify that your customer is in good financial standing before you go into business with them. Most credit checks will also show you a customer’s average number of days to pay, so you can know when to expect the factoring company to be able to collect.
The second net is the collections team. This team is dedicated to making sure your customers do not get behind on invoice payments. Every factoring company will work to collect payments from customers as quickly as possible so they do not have to recourse you. It is also vital for the client to help when needed
The third net in place is a reserve account. This is usually an option for the carrier, and the factoring company will usually give you a better rate if you opt for a program with a reserve account. This account functions similarly to a savings account. Money from each invoice is set aside with the intent of saving up for emergencies. The more invoices you factor, the more money in the account. If your customer defaults on an invoice, the money for that invoice comes out of the reserve account instead of your pocket. All these buffers work together to keep your business going forward.
By definition, non-recourse factors will not hold you accountable for an invoice if your customer defaults on the payment. However, this comes at a price and is rarely the actual case. Most non-recourse factors only protect you when your client defaults on an invoice in certain situations – generally, only when the customer has declared bankruptcy. They will actually recourse you in many situations, but call themselves non-recourse because they don’t recourse when a certain situation happens, which is a very rare occurrence. These factors generally have higher fees/rates, taking more up front from your invoices. They also may limit who you can do business with or limit how often you do business with the same customer in order to protect themselves from defaulted payments. Watch out!
The bottom line is that all factoring companies recourse in some way. TAFS does not believe in offering smoke and mirrors to clients to gain a quick buck on the front end. For a factoring company to be successful in the long run, the clients need to be successful as well. The best way to know what you are really getting into is to ask a factoring company directly “in what circumstances do you recourse or hold money”. Then, thoroughly read the agreement to verify if what they said is true. If you have questions on some of this tricky contract language, TAFS experts are here to help.