Recourse Factoring vs. Non-Recourse Factoring

Last Updated August 27, 2024

In order to survive in today’s competitive market and ultimately generate a competitive edge, a company must weigh the short-term and long-term implications of various funding solutions, one of which is invoice factoring.

Factoring can prove a great way for small business owners to improve cash flow. But before partnering with a factoring company, there are two different types of factoring you need to familiarize yourself with: recourse and non-recourse.

This article provides a comprehensive overview of recourse vs. non-recourse factoring.

What Is Factoring?

Invoice factoring occurs when a business, after invoicing its customers, sells the outstanding accounts receivable to a third-party factoring company (also known as a “factor”). The factor then advances up to 90% of the value of each invoice to the business, this typically occurring within 24 hours. Through this process, the business receives money immediately, rather than waiting for the customer (their debtor) to submit payment.

The parties involved in a factoring agreement neither acquire nor issue debt as part of the transaction. Hence, factoring can’t be considered a loan.

Consequently, invoice factoring has become a hugely popular alternative form of financing. It has proven to be crucial for countless small and medium-sized enterprises (SMEs) by fostering entrepreneurial ventures and greatly strengthening economic growth.

Why Do Small Businesses Utilize Invoice Factoring?

According to Bloomberg, the global market size of factor finance services is predicted to strike an overwhelming summit of $5,384.0 billion by the year 2027.

This is likely because factoring directly solves one of the most common challenges for small businesses: maintaining healthy cash flow and working capital. Business owners that factor their invoices have a far more predictable cash flow because you know you’re getting paid for your services provided within 24 hours. If working on net payment terms such as net 15, net 30 or net 60, you’re likely going to be waiting weeks to receive payment. And you might be surprised at how often invoices are paid late—recent data shows this occurs 55% of the time.

What Is Recourse Factoring?

With recourse factoring, the client is prompted to buy back any invoices for which the factoring company cannot collect payments. In order to cover unpaid invoices, it is advisable that the client sells the debt (debt factoring) to the factoring company at a discount.

If your liable customer fails to pay within some specified period, the factoring company may charge the invoice back to you or you can replace it with another good unfunded invoice. The factoring company effectively shifts the risk of non-payment to you. Essentially, when accounts receivable is factored with recourse, it means that the client is responsible for covering unpaid customer invoices, not the factor.

Advantages of Recourse Factoring

Factoring with recourse is the more common of the two types of factoring, with several advantages:

• Enhances quick cash flow for immediate needs.
• The client has no obligation to handle collections.
• The cheaper option for invoice sellers due to smaller factor fees.
• Stimulates greater business cash flow due to more cashback from invoices.
• Faster approval process.
• The factor is tasked with credit checks and in-depth verification of invoice clients to minimize the risk of defaults.
• The client can either pay back “bounced” invoices or have them exchanged with others upon default.
• The factor may avail options to help cover the cost of recourse on the client’s part.
• It leaves no debt on the client’s balance sheet as it isn’t a loan.

Disadvantages of Recourse Factoring

Nobody wants to take a blind pick without a clear picture of the downsides. So, here’s a highlight of the few prominent downsides of factoring with recourse:

• Less tight credit checks are done on the client’s debtors; the factor may enjoy recourse and has less risk in the event of non-payment.
• If a client fails to settle the default promptly or offset it with a good invoice, it could take a toll on their business income and bank accounts.
• Invoice offered in exchange for an unpaid one has higher pricing.

What Is Non-Recourse Factoring?

Here, the factoring company will take on most of the liability of non-payment by the client’s debtors. And because of this, they’ll want steeper discounts on unpaid invoices. Essentially, there are specific situations in which your company is not responsible for customer non-payment.

It is worth noting, however, that the client is not absolutely immune from all risk. Non-recourse factoring has associated provisions. Typically, most factoring companies offer non-recourse in the exclusive case of debtors who declare bankruptcy.

Still, such debtors must have good credit ratings to be considered. While the factoring company gives a credit guarantee that they are responsible for collecting your invoices, there’s no warranty that you are hedged against products or services disputed by clients.

So, in a nutshell, non-recourse factoring is distinguished from recourse factoring in that the factor accepts the non-payment credit risk of your clients.

Advantages of Non-Recourse Factoring

On the upside, non-recourse factoring is characterized by:

• High level of bad debt protection for the client
• Enhances cash flow and working capital
• Clients can provide payment terms to their debtors
• The factor is tasked with credit checks and in-depth verification of invoice clients to minimize the risk of defaults.
• Relatively easy to get funding compared to alternatives like a business line of credit (LOC)
• Simple application & fast deployment
• Can be open for short term funding, say three months

Because the factoring company will be assuming that risk on your behalf, many factors engaging in non-recourse factoring agreements with your business will run commercial credit reports on your debtors through one of the major commercial credit bureaus: Experian, Dun & Bradstreet, and Equifax.

This helps them establish your current clients’ financial standing and better identify the customers who could potentially be a greater risk for slow or non-payment of invoices. Identifying such clients is useful for not only the factor, but for your business as well. Knowing who among your current or potential customers could present payment problems helps you prevent such problems in the future.

Disadvantages of Non-Recourse Factoring

Of course, the added protection from non-recourse factoring is not without its disadvantages. It is in the factoring company’s best interest to ensure the invoices they have purchased get paid in full and on time. To better achieve that, the factoring company may:

• Not approve all customers or invoices for factoring. Since they are assuming the risk if a customer doesn’t pay for a qualified reason, it is in the factor’s best interest to only approve factoring invoices they feel confident clients will pay.
• Charge a higher rate. They need to be able to cover themselves from unpaid invoices through trade credit insurance.
• Offer a lower credit limit for factoring lines. The factoring company’s trade credit insurance will seek to ensure their protection by placing limitations on factoring line size.
• Reduce or end a credit line. Because of the greater potential risk to the factor, non-recourse factoring lines are monitored with scrutiny and subject to reduction or end of credit as a preemptive measure.

Recourse vs. Non-Recourse Factoring

If you’re still not sure what the differences are between recourse vs. non-recourse factoring, check out the summary table below:

	Recourse Factoring	Non-Recourse Factoring
Who Has the Liability of Non-Payment?	The client	The factor
Advance Rates	Typically higher	Typically lower
Cost	Typically costs less	Typically costs more
Speed of Approval	Typically faster	Typically slower
Which Is Best for Me?	Recourse factoring is typically better for clients with reliable customers and those who want lower factoring fees.	Non-recourse factoring is typically better for those with a higher risk of bad debt due to less reliable or riskier customers.

Example: Recourse vs. Non-Recourse Factoring

To provide an illustration of recourse vs. non-recourse factoring, let’s say an ice-cream startup, “Cup or Cone,” has a new vendor, ABC Groceries, on net 30 payment terms. ABC Groceries fails to abide by the terms on just the second payment cycle, causing Cup or Cone to suffer some serious budget problems.

To avoid these cash flow problems going forward, Cup or Cone partners with altLINE to boost their working capital and get back on track. Cup or Cone and altLINE have contractually agreed to factor with recourse, and ABC Groceries will going forward submit invoice payments to altLINE.

Unfortunately, ABC Groceries repeats the cycle, but this time doesn’t just fail to meet payment terms, they fail to pay the invoice entirely. Because Cup or Cone factored with recourse, they will be the party held liable for the failed payment. altLINE understands that this was out of Cup or Cone’s control, so the two parties work together to help find an optimal solution in the interim until payment is made. However, if payment is never submitted by ABC Groceries, Cup or Cone will be required to pay-back altLINE for the total amount of the cash advance that was provided.

In Summary: Recourse vs. Non-Recourse Factoring

A client should engage in a detailed discussion with a reputable factor on the latter’s terms regarding recourse vs. non-recourse factoring. And generally, to incur lower fees and worry less about risks, the best option is to ensure debtors have solid payment histories and impressive credit ratings.

Both full recourse and non-recourse types of invoice factoring have advantages and disadvantages to the business seeking to engage a factoring company. Overall, non-recourse factoring offers an additional sense of protection against clients defaulting on invoices owed to the factor due to customer insolvency, but it often comes with a higher price and limitations.

FAQs

What does it mean when accounts receivable is factored with recourse?

When accounts receivable is factored with recourse, it means the business using invoice factoring is liable for their customer failing to pay the invoice, not the factoring company. This differs from non-recourse factoring, where the factor is liable for any missed payments.

What is full recourse factoring?

With full recourse factoring, the client bears responsibility for their customer not paying an invoice to a factoring company. Full recourse factoring can be used interchangeable as factoring with recourse.

Which is more common between recourse factoring vs. non-recourse factoring?

Recourse is more common than non-recourse factoring. Many factoring companies are weary of non-recourse as it means they are liable for debtor non-payment.

Still, there are many advantages to working on a recourse agreement for business owners. For one, advance rates are usually higher. Plus, approval times are generally quicker. You also get the benefit of all of your debtors being credit checked, which can assist you in the long run with identifying potential problem customers.