What Non-recourse Factoring Is & How It Works

Non-recourse factoring is a kind of factoring relationship where the business that sells its invoice isn’t held liable if its customer fails to pay. In non-recourse factoring, it is the factor that assumes this risk. This type of factoring is rarely offered to business owners unless the debtor is a government or major corporation that has a stellar track record of debt payments like Walmart or Amazon.

How Factoring Without Recourse Works

When a company factors its invoices, the factoring company typically pays it in two installments. The first installment, called the advance, typically covers 75% to 90% of the total value of the invoice. The factor pays the second installment, which consists of the remaining balance minus the factor’s service fee after it collects on the invoice.

Depending on the seller’s agreement with the factor, the seller typically only gets to keep the first installment should the customer default on the payment while the second installment remains with the factor.

A company factoring $10,000 without recourse may receive $9,000 in the form of an advance. If the debtor never pays the invoice, the company would not be liable for the $9,000. However, it would also forfeit the $1,000 the factoring company would typically pay— minus any fees—in the second installment.

What Non-recourse Factoring Does Not Cover

While the factor typically absorbs the advance in case the debtor doesn’t pay, a company’s non-recourse plan may vary, depending on the agreement with the factor. True non-recourse factoring, where the factor assumes full responsibility for collecting on the invoice while absorbing all the liability, usually is only offered to companies whose debtors have been assessed to be very creditworthy.

Most non-recourse plans will include stipulations that protect the factor from having to absorb losses due to certain kinds of client disputes. For example, a non-recourse factoring plan will typically not cover nonpayment that is due to a client being unhappy with the company’s product.

Some factors will even offer non-recourse plans that only cover nonpayment that is due to customer insolvency. That is to say, if nonpayment was due to anything other than customer insolvency, the seller needs to repurchase the uncollected invoice.

Non-recourse Factoring vs Recourse Factoring

In non-recourse factoring, the factoring company absorbs the risk and liability of debtor nonpayment. In recourse factoring, the seller is required to repurchase any invoices that the factor isn’t able to collect on. So, if the debtor defaults, the company has to repay the advance, effectively making it a very short-term loan.

Pros and Cons of Non-recourse Factoring

Non-recourse factoring entails more risk for a factoring company, so borrowers can expect the factoring rates to be higher than plans with recourse. For the same reasons, the advance rate in non-recourse plans is also lower.

Because non-recourse factoring puts the factor at greater risk of fraud, the factor conducts a more thorough background to determine customer creditworthiness, which means longer approval times for the seller.

Bottom Line

Factoring is a helpful way for businesses to get funding for their immediate cash flow problems. Because factors assume the risk of debtor nonpayment in a non-recourse plan, non-recourse factoring is a type of factoring that is ideal for businesses that want protection against bad debt.