In recent years, businesses of various sizes and sectors have learned about the benefits of factoring receivables in order to get financing for their cash-strapped companies. In a nutshell, factoring companies buy invoices in a matter of days providing the company in need with cash as fast as possible. The factoring company then collects on that invoice directly from the client (also called the debtor). Did you know, however, that there are two types of services: recourse and non-recourse factoring?
Why Does Recourse vs. Non-Recourse Financing Matter?
The key difference between recourse and non-recourse factoring is that with the latter, the company doesn’t have to pay up should the debtor go out of business or just flat out refuse to pay. With recourse, the company actually has to pay the factoring company back. For this reason, recourse financing can sometimes be less expensive (in the short-run) than non-recourse financing.
What’s Really at Stake with Recourse Factoring?
Some companies may opt for recourse to try to save a buck figuring there is no way that their client isn’t going to pony up the dough. In the grand scheme of things, they think “how often does that really happen?” The answer might surprise them.
Despite the fact that a legit factoring company vets and runs a credit check on a debtor, there remains the chance that the debtor doesn’t pay. Business owners who think it won’t happen to them – particularly in this economy – might be accused of being overly optimistic.
It is hard to give numbers to such incidents but with freight or transportation factoring, it happens with some frequency maybe even as much as 30 to 40 percent of the time. Businesses that think about saving a few dollars by opting for the lower cost recourse option may end up having to pay more in the end.
What a Recourse Financing Company Really Means
Though it might not be clear to those new to this type of financing, capital and financial depth are key components that truly separate resource from non-resource factoring companies. To be able to absorb a major loss and accept higher risk financial risk requires a financial institution to have sufficient capital.
Many so called recourse-only companies lack the financial capital to cope with the loss that would be sustained if a debtor failed to pay. This tends to be the main reason such an institution only offers recourse factoring. Of course they probably don’t advertise it as such but chances are if they had the capital to offer non-recourse financing, then they probably would.