Thursday, June 23, 2011

Recourse v. Non-Recourse Factoring

It's all about credit risk. If you sell on open credit to your customers, there will be times when you are concerned about repayment. The first question you should ask yourself is: Why would I sell on open credit to a questionable credit risk? The second is: Is it worth it?

I have seen so many business owners willing to stake the future of their business on a potentially profitable deal with a poor credit risk. Yes, the deal and margin may be attractive, but if the customer does not pay (for whatever reason), will it kill your company? Often people do not understand that all transactions are NOT created equal, and some of them, even though the return might be in the 30-40% range, are not worth doing. Think about it this way: If I had information that indicates the customer in this deal has a high probability of not paying, would I put my money into it? Why would a funding company if I wouldn't?

Recourse factoring allows for the funding advance of your receivables much in the same way a non-recourse program would, but there are major differences:

1. With recourse factoring you retain the credit risk of non-payment. In the event your customer goes bust or just doesn't pay, you are ultimately responsible for any funds advanced to you by the factoring company. With non-recourse funding, the factor takes 100% of the credit risk.

2. Recourse factoring is typically less expensive than non-recourse.

3. Non-recourse funders are very cautious about what debtors they will consider eligible for funding as they take on all the credit risk. Weak credit on your customers = probably not a viable non-recourse debtor.

4. Collection calls in a non-recourse arrangement may be more aggressive than in a recourse program. I qualify the "may" in the previous sentence, but my experience has been that clients have been bothered by the efforts of non-recourse funders to collect in some instances when the funder gets concerned about seeing their money back.

5. If you have quality customers who pay near their stated terms, what is the point of needing/wanting non-recourse funding?


Recourse factoring is typically less expensive, and with the addition of credit insurance can function similarly to non-recourse funding regarding risk. If you are selling to high quality customers (from a credit perspective), then recourse funding makes more sense. Also, factoring companies tend to be much gentler in their approach to verification calls/contact with your customers in a recourse arrangement.

Non-recourse funding is typically done in the trucking industry, though some factors will consider it in any industry provided the creditworthiness of the customers warrant it. Rates are typically higher than recourse programs, and advances can be limited due to debtor credit and concerns about repayment. If your main purpose of wanting a non-recourse program is to eliminate the credit risk of dodgy customers, then you are probably out of luck and need to reconsider using a recourse factor who will help you on the credit decisions and collection efforts.

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