Most factoring companies offer invoice factoring with full recourse. This means that your company has to return the advance (and sometimes pay fees) if your customer does not pay their invoice within the specified factoring time frame – usually 90 days. The two most common reasons why factoring companies exercise recourse and return the invoices to a client are customer disputes and credit problems. This is one of the reasons why factoring should be used as a tool to accelerate your cash flow and not as a tool to handle old or un-collectable invoice.
Let’s explore the two most common reasons for recourse in more detail:
- Customer disputes: Invoices that are not paid on time because of a customer dispute represent the vast majority of invoices that are returned to clients. Sometimes these disputes are the result of a small misunderstanding. Other times, there are the result of huge misunderstandings. Regardless, your factoring company is not in a position to be the judge or arbiter in this situation which is why they sell the invoice back to your company. Most invoice disputes can be prevented by good communication and setting proper expectations with your customer. Additionally, using a verification letter can help you minimize invoice disputes due to misunderstandings.
- Credit Problems: Invoices that don’t pay due to client financial problems are also subject to recourse. However, these represent a small portion of the total invoices that are subjected to recourse because factoring companies are good at evaluating credit profiles. The don’t usually purchase invoices from customers with a slow or bad payment record. There is a form of factoring that offers some protection against customer credit defaults – it’s called non-recourse factoring.
Factoring agreements can be complex documents – because of this you should consult a competent lawyer before entering into an agreement with a factoring company.
Update: Here is a side by side comparison of recourse factoring vs. non recourse factoring.