The Fallacy of Non-Recourse Invoice Finance

In life it is important to distinguish between marketing and reality. When it comes to invoice finance, one marketing myth that has persisted is that non-recourse invoice finance shifts payment risk from seller to funder.

Unfortunately, non-recourse factoring is one of the most misunderstood subjects in commercial lending. As a result, companies undertaking some form of invoice finance, receivable finance or factoring tend to have the wrong expectation about this product, potentially incurring unnecessary costs and not truly understanding the credit-risk relationship.

Before we talk about non-recourse, let’s define recourse factoring. In recourse factoring, contract language can state that in the event any purchased account is not paid and collected within 120 days of invoice for any reason, then the Factor shall have the right to charge back such account to seller.

Essentially, recourse finance refers to if the funder purchases the invoice and the account debtor does not pay, or pays less than the full amount due to dilution (see Predicting Dilution is Key for Invoice Finance Solutions), the funder can then cover the deficit. They typically do this with the second installment payment. Note that in most factoring transactions, the invoice is purchased in two installments in an advanced amount (70-90% of invoice value), and the final payment costs less when the account debtor pays.

Most factoring companies (though not all) define non-recourse factoring along the lines of:

Non-recourse factoring is a type factoring facility in which the factoring company assumes the risk of non-payment if the customer does not pay the invoice due to an insolvency during the factoring period.

Non-recourse factoring only offers payment protection for the advance portion of the transaction. If the invoice defaults, you do not have to return the advance to the factoring company.

But non recourse factoring has been “sold” as a total shift of risk.  Lets look at an example.  An invoice is issued on 15 July, bought on a non recourse basis on 20 July, and to be paid by Account Debtor on 25 Aug.  If the Account Debtor goes insolvent in that time period, the customer still receives the advance payment by the funding institution.  But the risk of insolvency of the Account Debtor during this time period is highly unlikely in such a short time span.  It is easy to predict bankruptcy in the next 45 to 90 days, because of that, risk is low.

What non recourse doesn’t cover is dilution, and that’s why non recourse is marketing spin.  The risk for the invoice finance, or factoring or Asset based lender is during day 20 July to 25 Aug.  After that, the lender has recourse, because non payment can happen for many reasons besides insolvency.

Companies typically pay more for non-recourse financing as a supplier because the factor is assuming more risk. The reality as shown above is the risk is very low. There are new forms of factoring, call it digital invoice finance or factoring 2.0, where an invoice or portfolio of invoices are purchased from the sellers accounting system, so it is issued and “verified” but not approved by his customer (or buyer). The advantages of digital invoice finance are many compared to traditional invoice finance, such as no application fees or additional charges, no long-term commitments and, of course, no confusion around recourse and non-recourse.

Remember, definitions on the internet about non-recourse factoring tend to make it look like the company has no liability with any uncollected invoices coming from the account obligor and the factor absorbs all the payment risk. Non-recourse typically just applies during the period of time until payment due date from the account debtor.

As usual, the devil is ALWAYS in the detail!

David Gustin runs a research and advisory practice centered on helping financial institutions, vendors and corporations understand the intersection of trade credit, payments and the financial supply chain. This post was written while David worked on a special project with The Interface Financial Group.

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