Factoring is when you sell your invoice to a 3rd-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 on the invoice? Who is responsible for the payment? From here the industry is broken down into 2 categories: recourse and non-recourse.
The more straightforward of the 2 options is recourse. Recourse factoring is when a factoring company resells you 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.
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.
The second net is the collections team. This team is dedicated to making sure your customers do not get behind on invoice payments.
The third check in place is your 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 not always the case. Non-recourse factors generally have high fees, taking bigger chunks upfront 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. Lastly, some non-recourse factors only protect you when your client defaults on an invoice in certain situations – generally, only when the customer has declared bankruptcy. Otherwise, the non-recourse factor will charge you back for the invoice. Watch out! Non-recourse factors sometimes do not set up reserve accounts for you which means you probably will be paying for that defaulted invoice out of your pocket.
Each trucking company is different. When picking a factoring company, choose one that will best fit your business requirements.