Reviewing Types of Invoice Factoring - Recourse vs Non-Recourse, Spot Factoring vs Contract Factoring

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There are two main types of invoice factoring, recourse and non-recourse. One places responsibility for nonpayment on you, the other places that responsibility with the factoring company. Within recourse and non-recourse factoring, you also find spot and contract factoring. One requires a contract (the names should tell you which one that is) while the other does not. Although each of these pairs seems to have one clear winner (at least from the client's perspective), there are benefits to both.

What Is Recourse Factoring?

With recourse factoring, you, as the client, assume all risk for whether an invoice is paid. In practice this means that, if the factor buys the invoice and pays you the agreed advance, the factoring company has recourse to collect the money owed from you rather than your customer. In addition, you typically still have to pay the factoring company's standard fee.

While this sounds like all downside for you, there are some benefits to recourse factoring. First is the fact that you nearly always get a lower rate from a recourse factoring company than you do with a non-recourse factoring service. Why? Because they don't need those extra fees to cover the invoices they never collect on.

Another benefit is that the factoring company's underwriting process includes financial screening of your customer. This reveals the client's previous payment issues, its financial health (bank balances as well as monies owed to other creditors), and similar financial information. This depth of information is why the factor deems certain customers unacceptable.

The way recourse factoring works is that, if your customer does not pay the full amount due within the specified timeframe, you must buy the invoice back from the factor in what is referred to as a charge back. The timeframe is usually 75 or 90 days, depending on the terms of your agreement.

What Is Non-Recourse Factoring?

With non-recourse factoring, the factoring company assumes all of the risk for nonpayment of invoices and typically charges higher fees to compensate for the occasional unpaid invoice.

Please note that most agreements include clauses designed to protect the factoring company in the event of nonpayment. These clauses may require you to buy back the invoice after all, or may lead to an adjustment of your agreement. In addition, disputed invoices are rarely covered by non-recourse factoring. If your customer returns a product or disputes the invoice for any other reason, you have to buy it back as you would if you were working with a recourse factoring company.

Recourse vs. Non-Recourse Factoring

Determining which is best depends on your unique circumstances. If your clients have a history of paying their invoices in full and on time, recourse factoring may be the best option for you. The rates are lower and you can be fairly certain the invoices will be paid. Those lower rates likely make up for the occasional unpaid invoice that you must buy back. This is especially true if the service allows you to choose which invoices you factor, since you may be able to choose only those clients that history tells you are reliable about paying their bills.

Another tick in the recourse factoring "pro" column is the fact that most non-recourse factoring companies include those clauses that shift some of the responsibility onto you anyway. Read contracts carefully, as this is where all of those caveats are listed. Review each option to determine which is truly the best one for your company.

What Is Spot Factoring?

With spot factoring, you don't sign a contract with the invoice factoring service. The process is otherwise the same as in standard invoice factoring. You submit your invoice, the factor approves and advances funds at the agreed upon rate. Then, once they receive payment from your customer, they subtract their fee and advance the remainder to you. Until you're ready to spot factor another invoice, you have no further obligation.

This is not as common as contract factoring, because it heavily favors the client (you). However, some spot factoring companies implement minimum invoice amounts to ensure profitability for handling these clients. You may also extend your relationship to the more traditional contract factoring if your needs change.

What Is Contract Factoring?

Contract factoring is much more common than spot factoring. It requires you to sign a contract for a certain number of months. In addition, it usually requires you to factor most or all of your invoices. The fees to sell your invoices are typically lower, though you likely have more "extra" fees, such as monthly minimums, credit check fees, and maintenance fees. However, you also typically enjoy perks denied to spot factor merchants. You also get the benefit of the factoring service growing to truly understand your customers and your industry, increasing their value as a partner.

Spot Factoring vs. Contract Factoring

Factoring companies tend to prefer contract factoring over spot factoring, since they do the same amount of work for both, but get more money when there's a contract involved. Contract factoring is far more common for those reasons. However, if yours is a smaller business, or if you apply different terms to different clients, you would likely benefit more from spot factoring. It also offers a great deal of flexibility and, of course, you aren't tied to a contract, which can be a big benefit if your needs change.