All types of financing involve risk. In the field of invoice factoring, the risk is usually derived from insolvent customers. In invoice factoring contracts, either the factor or the client company assumes the risk of nonpayment. Understanding financial risk can help you choose the right type of factoring arrangement for your company’s needs.
The main difference between recourse and non-recourse factoring is what happens if your customers don’t pay their invoices. In this situation, when your clients don’t pay, your factor has a recourse.
Recourse factoring is an understanding between your business and the factoring company that your company must buy back receivables for which the invoice factoring company could not collect payment. Essentially, if the customer doesn’t pay their bill after a certain period of time, you are responsible. Your business will have to reimburse the factoring company the money it paid for the customer’s invoice.
The main benefit of recourse factoring is that it is typically less expensive than non-recourse factoring since the invoice factoring company only assumes partial rather than full liability.
With non-recourse factoring, if your customer doesn’t pay, you are not liable for their bill. Non-recourse factoring is typically more expensive than recourse factoring because the invoice factoring companies assume all of the risk and liability. The primary benefit, however, is that your company assumes no responsibility for the invoice; once it is sold, your business never has to deal with that invoice again.
Factoring companies realize that there is risk involved in any lending situation, so they consider many aspects before approving funding. Non-recourse factoring is not available in all situations.
Modified Recourse Factoring
Modified recourse factoring has elements of both recourse and non-recourse factoring. With this type of factoring, the invoice factoring company carries receivables or credit insurance that can offer protection for your business if your customer can’t pay due to issues like bankruptcy. However, some situations aren’t covered; for instance, if the customer refuses to pay because of service quality, your company may still be liable to reimburse the factoring company should invoices remain unpaid.
How to Choose the Option for Your Business
Remember that your business can factor invoices individually. When deliberating between recourse and non-recourse factoring, carefully consider questions like:
- Does this customer pay their bills? If so, then there is probably minimal risk of them not paying the factoring company back. Recourse factoring may be your best option in this case, because it would save your business money (since it’s less expensive than non-recourse factoring) and you won’t be very likely to have to repay the factoring company since said customer never or rarely defaults.
- Does this customer regularly default? If they don’t pay you, they probably won’t pay an invoice factoring company either. With recourse factoring, your business may have to pay the factoring company for what your customers won’t, whereas with non-recourse factoring, the invoice factoring company assumes full responsibility for invoices acquired.
- How well do you handle the pressure of not knowing what will happen? If worrying whether your customers will pay the factoring company back for invoiced amounts will keep you up at night, consider non-recourse factoring. As previously mentioned, once the invoice is sold to the factoring company, you can rest easy knowing it’s out of your company’s hands.
Talk to Your Factoring Company
At Bayview Funding, we look at your company’s needs and evaluate your customer’s background to help you find the factoring solution that’s best for your company. If you’re not sure which option to choose, our factoring consultants are always on hand to help you through the process. Contact us today for a free quote.