Accounts Receivable Factoring Agreement
Recourse Vs. Non Recourse
An accounts receivable factoring agreement is a legal binding contract typically lasting a full year or longer. There are some companies that contract on a half year basis and a few which even do a monthly contract. However, the fees involved in shorter term contracts can be higher.
Because the agreements mostly long term in nature, there are a few important components of a factoring agreement to carefully consider which I will attempt to highlight.
Factoring Agreement with Recourse
A factoring agreement with recourse is an agreement where you as the holder of the receivable retains the risk in the event your customer does not honor payment.
For example, if you sell or factor a sum of $1,000 owed to you by Customer A to Company B, and Customer A does not end up paying Company B, Company B will expect you to pay them instead.
Company B, the company that buys your accounts receivable at a discounted price is also referred to as the “Factor” or “Factoring Company”
Factoring Agreement with No Recourse (non recourse)
The opposite of recourse is non recourse.
In a non recourse factoring agreement,Company B retains all the risk in the event Customer A doesn’t pay them.
Company B cannot come back to you and ask for payment.
It is important to understand both types of agreements and choose one that fits your objectives.
There are advantages and disadvantages to both, with the accounts receivable factoring cost being the biggest component. The more risk you retain, the less in factoring fees you will pay.
Factoring Fees and Terms
The fee structure involved in factoring agreements typically involve an initial set up fee, a payment percentage based on the volume of the receivable and the interest rate (also referred to as the discount rate).
Couple more things to keep in mind: There is typically a timeline involved for when the buying company expects to be paid by your customer. In the event it doesn’t get paid within the contractual timeline, it may charge you additional fees and interest rates.
In addition to the timeline, there are clauses that protect the Factoring company from customer fraud and payment default. In either case, your business is typically “on the hook”.
Even though accounts receivable factoring is not a loan, Factoring companies may require additional collateral aside from the customer accounts receivable to feel more secure. Collateral can be a lien on your assets such as inventory, or rights to additional receivables that are not under the factoring agreement.
The type and amount of collateral will typically depend on your relationship with the company and the amount of time you have done business with them.
Concluding Thoughts on Accounts Receivable Factoring Agreements
An accounts receivable factoring agreement is necessary to formalize a factoring relationship between a business and a company who buys its receivables in exchange for a discounted cash value.
And because there is a substantial risk involved to the buying company, or the “factor”, factoring contracts are generally more favorable to the buying company.
Take your time and carefully consider each component of the contract to ensure the agreement is fair to both you and the company buying your receivables. Is accounts receivable factoring safe for your business?