Non-Recourse Factoring & Recourse Factoring
Learn the differences among recourse, true non-recourse and modified non-recourse factoring
If you’re considering factoring as a funding solution, it’s crucial that you understand the different options available. Factoring providers generally offer two different solutions: non-recourse factoring and recourse factoring. As a seller of receivables, the type of factoring you choose can significantly impact your balance sheet and your cash flow.
While non-recourse factoring is often the preferred solution, few factors offer “true” non-recourse factoring. Instead, many offer something best described as “modified” non-recourse factoring. The modifications are substantial, so you must understand the differences and identify the best solution for your needs.
“True” Non-Recourse Factoring
The primary benefit of using true non-recourse factoring is that it can bring clarity and strength to your balance sheet. Beyond that benefit, there aren’t many other advantages to using non-recourse factoring over recourse factoring.
True non-recourse factoring involves a true sale of the receivable. The factoring company assumes all responsibility for the collection and all liability should the debtor not pay for any reason (excluding dispute). The receivable is removed from your balance sheet, and cash is added as an asset. You have no further responsibility to monitor the debt or collect on it.
A non-recourse factoring solution may be desirable from a balance sheet standpoint. You are entirely removed from any further connection with the receivable. You get cash for the receivable and can move forward with your business.
The challenge, however, is that only some factors offer truly non-recourse solutions. Most true non-recourse solutions are only made available to large, multi-national companies with a roster of large debtors with solid credit. The receivables generally need to have high balances and low volume.
You may find a non-recourse solution only if you and your customers meet those criteria. Instead, more likely, your choices are between a modified non-recourse solution and recourse factoring.
“Modified” Non-Recourse Factoring
Modified non-recourse factoring is often advertised and communicated simply as non-recourse factoring. The word “modified” is added here to distinguish between this type of factoring and the true non-recourse options.
Modified non-recourse solutions are much like a true non-recourse option but with a few caveats. First, many non-recourse solutions will have a clause holding the seller responsible for any representations or warranties about the debt that the factor later finds inaccurate. This language is often nebulous and can be used to return the debt to you if the factor cannot collect. Typically, most factors only provide protection against debtor bankruptcy.
Also, in many non-recourse solutions, the seller must have credit insurance on the debt. Credit insurance can often be costly and challenging to obtain. Also, the insurance company may only agree to cover part of the amount on the invoice, making it difficult to sell your total sales to the factor. This is often an area of stress between the seller and the factor.
Finally, the costs for most non-recourse solutions are much higher for you than if you went with a recourse option. That will affect the cash flow you realize from entering into the factoring agreement.
The true benefit of any non-recourse solution is that it can strengthen your balance sheet by removing the debt and replacing it with cash. If you aim to unload a credit risk from your receivables portfolio, there may be better solutions than non-recourse factoring. You may either pay high factoring costs, or the debt will ultimately be returned to you.
Factors are experts at analyzing credit risk. They won’t take on unwarranted risk, and they won’t take on a high level of risk without exacting a higher cost in return. Before entering a non-recourse agreement, consider whether the debt and the customer are creditworthy. Also, look at the terms to see when and how the debt could be returned to you.
Recourse Factoring
Recourse factoring is the most commonly used form of factoring found today. Under a recourse factoring agreement, the seller must pay the factor if the customer does not pay its debt. At first glance, this may seem negative for the debt seller. However, there are several reasons why recourse factoring is often an effective solution for both the factor and the seller.
First, it’s important to remember that most factors want to maintain a strong and mutually profitable relationship with their sellers. At Gateway, we consider the recourse option a last resort rather than the primary means for collecting the invoice. That’s how most reputable factors operate.
To achieve that goal, we use our sophisticated credit analysis process to determine each debt’s creditworthiness.
For the seller, working with a recourse factor is often beneficial because the factor may take on debts that a non-recourse factor wouldn’t consider. The seller may also pay lower fees and may not have to worry about finding credit insurance on the debt.
The goal of the factor and the seller should be to work together in a cooperative, mutually beneficial relationship. Factors that rely on recourse instead of sound credit extension policies expose themselves and their sellers to unnecessary risk.
Before you go with non-recourse factoring, take some time to consider what benefit you’re getting from the agreement. In many cases, the non-recourse part only kicks in if the debtor cannot pay, often meaning the debtor must be near or bankrupt.
If your clients are high-quality and creditworthy, there may be no tangible benefit to using non-recourse factoring. Consider both non-recourse and recourse solutions as you look for funding.
Contact us today for more information on how recourse factoring can benefit your business. We welcome the opportunity to discuss your goals and needs with you.