Financing Your Business

Understanding the Distinctions Between Recourse and Non-Recourse Factoring

DELRAY BEACH, FL / ACCESSWIRE / January 16, 2024 / Business owners who benefit from using invoice factoring often face important decisions when starting a factoring relationship. While many businesses turn to factoring to improve their daily cash flow, some also seek protection in case a customer fails to pay. Let's delve into the difference between Recourse and Non-Recourse Factoring.

What sets factoring apart from Invoice Financing is that it involves an actual legal sale of an invoice between a business (referred to as "the Seller") and the factoring company (referred to as "the Buyer"). A key element of this transaction is the existence of a repurchase obligation, known as the recourse provision, that may or may not apply to the transaction.

There are two common forms of recourse offered: Full-Recourse and Non-Recourse. In Full-Recourse, the Buyer can request the Seller to repurchase an invoice at any time and for any reason. This typically occurs either on an agreed-upon date, often 91 days from the invoice date, or when an invoice is disputed, and the factor believes collection within 91 days is in jeopardy. Full-Recourse generally provides greater funding availability for the Seller, as the Seller acts as a secondary repayment source alongside the customer for the factoring company.

Non-Recourse is more nuanced and differs significantly in perceived protection and funding availability. Under Non-Recourse, once the Buyer advances funds, the Seller has no obligation to repay the factor. However, specific eligibility conditions to receive the Non-Recourse benefit are defined in the factoring agreement. Non-Recourse approval, or often defined as "Credit Approved," means the factor agrees in writing that a customer is approved for a specific credit limit with defined credit terms. If the customer does not pay, due to declared insolvency or protracted default, the Seller is not required to repurchase the invoice. Most factors offering Non-Recourse have a Credit Insurance Policy to protect against declared customer bankruptcies.

Non-Recourse can be restrictive and may limit what a Buyer is willing/capable to purchase, especially if they are strict about credit limits. This limitation can reduce the immediate cash benefit provided by factoring. Full-Recourse offers more flexibility in credit limits, subject to customer performance.

Non-Recourse tends to have higher costs than Full-Recourse because the Buyer likely will incur additional expenses for providing credit protection. The additional discount rate for Non-Recourse can range from 0.15 to 40 basis points every 30 days.

There are also some significant accounting considerations between Recourse and Non-Recourse arrangements that should be carefully considered.

The choice between Non-Recourse and Full-Recourse should be strategic and based on customer concentration and cash needs. If a business has a high exposure to a customer and the cost of protection is insignificant compared to potential bankruptcy losses, they may opt for Non-Recourse.

Regardless of Recourse or Non-Recourse, the spirit of the factoring arrangement is one where the factor expects to buy performing invoices albeit slow paying but fully collectable. Occasionally an instance may arise where a customer may dispute an invoice or delay payment until resolution.

In the case of invoice disputes, factors will rely on the Seller to resolve the matter with the customer, leading to payment. If no resolution is reached the factor may request the Seller to repurchase the invoice, which comprises the up-front amount advanced and earned discount. In this instance, this would turn this specific invoice from a Non-Recourse into a Full-Recourse purchase.

Some factors offer integrated agreements allowing them to provide both Recourse and Non-Recourse options on an as needed basis, ensuring protection for both parties. Invoice factoring is gaining popularity in 2024 as banks reduce lending to small and medium-sized businesses.

Given the rapid rise of business bankruptcies in 2023 we can likely expect more of the same in 2024. Factoring immediately improves daily cash flow and utilizing Non-Recourse for added protection in the coming years could be a wise business decision.

Gateway Commercial Finance, LLC provides both Recourse and Non-Recourse factoring services to businesses across the U.S.

Marc J. Marin
Managing Director
marc.marin@gatewaycfs.com
561-424-2940

SOURCE: Gateway Commercial Finance, LLC