Two Sides of the Factoring Equation
As defined by Investopedia, factoring is a form of asset-backed financing, a financial arrangement in which a company leverages receivables in order to obtain credit from a third party financier known as a “factoring agent.” Typically, a business owner will sell his receivables at a significant discount, collecting an advance of 70-80% of the purchase price.
In due course, once the factor has collected the full balance of payment from the client, the business owner may receive the entire balance, minus commission and charges. For business owners facing a sudden cash shortfall, factoring financing can provide a short-term solution.
The Risks of Recourse Factoring
Understanding the difference between recourse and non-recourse factoring will help your business target and secure appropriate financing terms, striking a stable balance between risk and opportunity.
When a company advances funds to a business owner based on outstanding accounts receivable, the lender expects to receive full payment from the client in a timely manner. However, if customers refuse to pay, then the lender may have “recourse” to reimbursement by the business owner. This is known as recourse financing, and it shifts the risk and responsibility for payment to the business owner.
Since a recourse creditor does not assume the risk of default, this form of financing is typically less expensive than non-recourse financing, in which the factoring agent accepts full responsibility for payment. Non-recourse finance is by far the most popular form of factoring financing for business owners in need of a quick cash injection.
As opposed to a small business loan, factoring is primarily structured as an outright purchase of accounts receivable on a non-recourse basis. The enables factoring agents to provide cash advances on creditworthy invoices to small-business owners in need.