You’re a small business owner and you need financing. The first stop is your local bank where you get the sympathetic shake of the head from the loan officer. “Sorry, we can’t help with a loan but how about a checking account?” A checking account isn’t going to cut it when you need cash for your business.
You have bills to pay. What now?
There’s invoice factoring, an option that puts money in your pocket fast—often the same day. With factoring, you sell unpaid invoices to a factoring company like Triumph Business Capital, which pays you the amount you’re owed on the invoice less a small fee, and then is responsible for collecting from your customer.
But what if your customer doesn’t pay?
There are two basic types of factoring: recourse and non-recourse. Recourse factoring is kind of like a loan in that if your customer doesn’t pay the invoice, you owe the money on that invoice back to the factor.
With non-recourse factoring, the factor evaluates the credit risk of your customer and agrees to take the loss if the customer can’t pay the invoice for credit reasons.
What Non-Recourse Factoring Doesn’t Cover
The “for credit reasons” phrase is important.
Most non-recourse factoring contracts have a clause that says you are responsible when the customer refuses to pay an invoice because of a “dispute of any kind, regardless of validity.” When a customer says your delivery was late and is only going to pay 50% of the invoice, or holds up payment because there’s a document missing, these are not credit-related issues. The factor is probably going to ask you for its money back.
What Non-Recourse Factoring Does Cover
Let’s talk about what non-recourse factoring does cover.
If, during a collection call, your customer says something like, “We simply do not have the money to pay these invoices right now,” you’re protected. If your customer’s business fails or files for Chapter 11 bankruptcy protection, the factor will be the one standing in line at the bankruptcy hearing, hoping to get paid. After all, it bought the invoice based on the creditworthiness of your customer.
Non-Recourse Factoring Gives You Control
As you can see, there’s a theme here.
With non-recourse, if a factoring service agrees to buy an invoice and the customer can’t pay it for credit-related reasons, you’re covered. But if the customer won’t pay due to your performance, you’re not covered. That’s not such a bad thing because you don’t want a third party handling discrepancies with a customer anyway. You probably worked hard to earn that business and if something threatens the relationship, it should be up to you to address it.
An experienced factor knows how to evaluate credit risk in your specific line of work. If you find that your factor is routinely asking you to pay money back (a “chargeback”) on invoices that you thought were non-recourse, get specific. Ask for details. Is it related to something that can be tied back to you and the performance of your business? Or is there some other reason the factor can’t collect?
Non-recourse factoring is a common and convenient way to turn something of value—your invoices—into the cash you need. Not all factoring agreements are the same so it’s important to read the contract and ask questions when you have them. If it’s confusing or you’re not getting answers, then maybe it’s time to look at someone else to factor your invoices.