Understanding Factoring A to Z
Factoring has been a trucking industry buzzword for years.
Since its introduction to the trucking industry decades ago, factoring has become a well-established means for trucking companies to get the cash they need to not only survive but to grow quickly and easily. That said, utilizing factoring to its fullest potential requires a deep understanding of the intricacies of the process.
It’s natural to have questions covering many facets of factoring, from the potential risks associated with factoring, to the costs of the process, to what paperwork is involved in receiving your cash. One of the most common questions people have when they decide to start factoring is: “What kind of factoring should I choose, recourse factoring or non-recourse factoring?”
The answer to that question is more complex than you may think. The two forms of factoring have different advantages and disadvantages that can make them a better fit for some companies than others. In addition, finding a true non-recourse factoring company is easier said than done.
Before diving into the specifics of recourse factoring, non-recourse factoring, and the differences between them, it’s important to first review the basics of factoring in general.
What is Recourse Factoring?
Now that we’ve covered the basics of factoring, it’s time to dive into the key question: “What does recourse vs. non-recourse factoring mean?” Let’s start by talking about recourse factoring, which is the most common and straightforward form of the two factoring options.
Recourse factoring works according to the process laid out above. The factoring company buys your invoice from you, giving you the value of the invoice minus a small fee. The company may give you the full value minus the fee from the outset, or they might give you a part of the value upfront and then the remainder once your customer has paid the invoice. In either case, you will get cash much sooner than you would if you had to wait the industry standard of 30, 60, or 90 days — or even longer in some cases.
That all sounds ideal, but here’s where the “recourse” part of recourse factoring comes in. With this form of factoring, your factoring company does not take on any of the risks associated with your invoice, mainly due to the fact that recourse programs are usually free from most customer credit approval requirements. They will still do everything in their power to ensure your customer pays the invoice, such as continuously following up with them and pushing them to make the payment. But if your customer defaults on the payment or makes a late payment, you’ll still be responsible for that default, not the factoring company.
The factoring company will contact you and charge you the amount they paid you for that invoice. That means that if the customer doesn’t pay, you’re the one who will lose money, not the factoring company. This is why most recourse programs hold a reserve from the initial funding, to cover invoices that are charged back so it doesn’t always directly affect the carrier’s immediate cash flow. That said, there is no guarantee that the funds you receive from the factoring company after submitting your paperwork will be yours to keep until your customer has paid the factoring company. Until then, there’s still a chance that you’ll be responsible for returning that money to the factoring company if your customer defaults.
That kind of risk is not particularly appealing for smaller operations. Recourse programs are typically designed for larger freight fleets, since they can run with non-approved brokers and have the ability to absorb that risk if needed. However, factoring companies do typically have some safety nets in place to prevent chargebacks from occurring.
The first of these is the credit check system. Although recourse factoring carriers are able to factor invoices from customers who are not credit approved for non-recourse carriers, having access to credit and risk information when looking for a new customer to work with can make the process much easier to manage. Factoring companies will usually perform a credit check on your customer for free before agreeing to factor the invoice. These credit checks will also typically show the customer’s average days to pay. This process gives you the important information you need to determine if the client is in good financial standing and worthy of your business.
The second safety net is the factoring company’s collections team. One of the many advantages of factoring is that you’re no longer responsible for making phone calls and collecting payments on your invoice — the factoring company will do that for you. It is in the factoring company’s best interest as well as your own that you get paid by your customer. That means they’ll work hard to ensure your customer does not fall behind on their invoice payments. In some cases, you may need to assist the factoring company if they’re dealing with a challenging customer. It’s important to provide whatever support you can.
There will always be a small amount of risk associated with recourse factoring, but not factoring is also risky. After all, if you don’t factor and a customer doesn’t pay, you won’t end up with the cash you earned anyway. The only difference is that with factoring, because you received the money upfront on the assumption that the customer would pay, you are then responsible for paying that money back to the factoring company if the customer defaults. This worst-case scenario of not receiving payment for your hard work is the same whether you decide to use factoring or not.
The key points to remember when it comes to recourse factoring are that recourse factoring:
- Is the most common form of factoring
- Has more flexible credit requirements for your customers
- Has lower fees
- Does not assume any risk if a customer doesn’t pay the invoice, meaning you are responsible for failed customer payments
- Has a personal guarantee requirement
What is Non-Recourse Factoring?
Non-recourse is the other main category of factoring. Non-recourse factoring is also straightforward — in return for a slightly higher fee, the factoring company will take on the risk of an invoice not being paid by your customer. That means that even if the customer defaults or is late for whatever reason, you get to keep the money you were already paid off of the invoice.
The problem is that the vast majority of companies that claim to offer non-recourse factoring — all but one, in fact — don’t offer that. In the majority of cases, the only situation in which the factoring company will not charge you back for an unpaid invoice is if the customer files for bankruptcy between the time you submit the invoice and the customer pays it. This happens very rarely because broker checks are required for non-recourse programs, meaning that a factor will almost always prevent you from factoring with a failing or near-bankrupt broker in the first place. Most unpaid invoices occur for a wide range of reasons that are not covered by non-recourse factoring companies. The result is that most non-recourse options are actually recourse options by another name — but with a higher fee attached to them.
Let’s take a look at a few of the most common situations many typical non-recourse factoring fail to cover:
- Disputed invoices — all non-recourse programs will charge a disputed invoice back to the carrier and do not take on liability for payment issues caused by the carrier during transit
- Invoices sent by the client directly to the customer instead of the factoring company
- Invoices where the client has breached its agreement with the factor
- Invoices that are offset by other amounts due to the account debtor
If any of these situations arise, your typical non-recourse factoring company will send you a chargeback. To avoid those kinds of nasty surprises, it’s essential to research your non-recourse factoring company before making any decisions and take time to understand what’s covered and what isn’t. Read the small print on your proposed contract early in the sales process and search for sections having to do with recourse. They might have headings with words like “recourse,” “credit problem,” or “credit event.” In many cases, it will likely make more sense to take the recourse route since your non-recourse contract will simply be a recourse contract with higher fees.
If you’re interested in true non-recourse factoring — the kind of non-recourse factoring where the small print doesn’t include any surprises like fees and chargebacks — there’s only one option on the market for you: OTR Solutions.
Unlike other factoring companies that claim to offer non-recourse options that don’t take on any risk, OTR Solutions fully accepts the risk associated with your invoices. That means that if your customer doesn’t pay for whatever reason, OTR Solutions will accept the loss without charging you back for the amount of the invoice. That guarantee can prove transformative for any carrier or owner-operator — particularly those running smaller operations. With OTR Solutions, you get real non-recourse factoring and the many benefits — like increased peace of mind and confidence — associated with it.
Here are a few non-recourse factoring takeaways to keep in mind. Non-recourse factoring:
- Is less common than recourse factoring
- Is, in all cases except for OTR Solutions, simply recourse factoring by another name because you are only covered if your customer files for bankruptcy
- Comes with slightly higher fees
- Has more stringent credit requirements for your customers
- Often has a lower advance rate than with a recourse transaction (meaning the factoring company holds off on paying a larger part of your invoice until after they’ve received payment from the customer)
- Does not usually have a personal guarantee requirement