Recourse factoring is the most common type of invoice factoring. The business that sells a customer’s invoice retains the risk and liability if the debtor fails to pay. This means the seller will essentially have to repurchase receivables sold to a factor if the lender can’t collect on the invoice. This effectively converts a factoring advance into very short-term debt.
How Recourse Factoring Works
When a company factors its invoices, it typically receives two payments. The first payment, called the advance, covers 75% to 90% of the total value of the invoice. The second payment consists of the remaining balance minus the factor’s service fee. The business receives this payment when the factoring company collects the invoice.
The recourse factoring agreement typically will specify the maximum number of days after a receivable’s maturity date before the advance should be returned. If a debtor doesn’t remit payment for the receivable within the agreed-upon time, then the factor will require the seller to either return the advance or replace the amount lost with another invoice.
Recourse Factoring vs. Nonrecourse Factoring
In recourse factoring, the seller is required to repurchase any invoices that the factor isn’t able to collect on. By comparison, in nonrecourse factoring, it is the factor company that absorbs those same risks and liabilities, leaving the seller unaffected in the event of debtor default.
Pros and Cons of Recourse Factoring
Recourse factoring has all the advantages of factoring in general, which is to say that it is cheaper than conventional bank lines of credit, and it is easier for small businesses to qualify. Recourse factoring also delegates bill collection to a factor, allowing businesses to focus on their other operations. Recourse factoring plans also will offer both a higher advance and lower factoring rates compared to nonrecourse factoring plans.
Most small business owners considering invoice factoring will receive a recourse factoring agreement. In that case, the usual factoring drawbacks apply. Advance rates can be low, and the factoring company may contact customers to collect on past due invoices. It also can be costly in the long run. However, for many small business owners, it’s the best option to borrow large sums and finance growth.
Factoring is a helpful way for businesses to get immediate funding. Recourse factoring, the most common type of factoring relationship, is typically the fastest and least expensive way for a company to be able to address its immediate cash flow problems.