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A Non-Recourse Factoring Agreement Sample: Explained

If you’re looking to sell your invoices as a way of raising capital, it’s important to understand the differences between recourse and non-recourse deals. Essentially, recourse factoring means you (or your business) is on the hook if your customers don’t pay the invoices you sold to the factoring company, and non-recourse factoring means you’re not on the hook. Think of non-recourse deals as “no strings attached” financing – the factoring company completely assumes the risk that the invoice won’t be paid by your customer.

Obviously, there are many benefits to obtaining non-recourse accounts receivable financing. The credit/collection risk being assumed by the factoring company is the greatest benefit. So while you’re out looking for the best deal, be sure to reference this article. Despite the title, instead of providing you with a non-recourse factoring agreement sample, we thought we’d provide you with language that raises red flags – language that signals a deal is recourse. Since recourse deals have increased potential liability associated with them, it’s important you know how to identify the differences. But please don’t get us wrong here, recourse deals aren’t necessarily bad. Because the factoring company doesn’t assume as much risk, the fees are usually lower. But if you’re not willing to assume the risk of a recourse deal, you need to know how to identify one.

#1. Look for Specific Liability Language

When you read recourse language, you’ll know it. Typically a deal that doesn’t have recourse language is non-recourse, therefore you should look for recourse language. The factoring agreement (also known as a “Purchase & Sale Agreement”) will have something like this:

“Seller shall offer for sale to Purchaser as absolute owner, with recourse, Seller’s Accounts as listed periodically on the Seller’s accounts receivable schedule…”

Whereas a non-recourse deal will have language like this:

“Seller hereby agrees to sell and assign to Buyer, and Buyer hereby agrees to purchase from Seller, certain accounts arising from Seller’s ordinary course of business…”

Notice how there is zero language about “with recourse” in the second quotation. Also, for purposes of a factoring contract, “buyer” and “purchaser” mean the same thing. The word and specific language of each clause depend on the factoring company’s attorney.

#2. Look for a Skewed “Repurchase” Clause

Sometimes, not but always, factoring companies will include a “repurchase” clause in a factoring contract. These clauses govern a repurchase of the invoice by your company, from the factoring company. Because factoring involves the “purchase and sale” of invoices, where your business sells invoices to the factoring company, a repurchase means you buy them back. This could happen for any number of reasons, like the invoice being outstanding for more than 90 days. Again however, it’s important to understand the language.

Purchaser may require that Seller repurchase, on demand, or, at Purchaser’s option, by Purchaser’s charge to the Reserve Account: Any Purchased Account, the payment of which has been disputed by the Payor; Any Purchased Account owing from an Account Debtor or Payor which (a) in Purchaser’s reasonable credit judgment has become insolvent or (b) has indicated an inability or unwillingness to pay the Purchased Account when due; Any Purchased Account that remains unpaid beyond the Late Payment Date.

Notice that in the above clause, the factoring company (the Purchaser) can force you buy back the invoice (the “Purchased Account”) on demand – even if your client has become insolvent, refuses to pay, or pays late.

We can’t say it loud enough – that is NOT a non-recourse deal!

Insolvency by your customer, late payment and refusal to pay are exactly the types of risks assumed by the factoring company in a true non-recourse deal. Also note that in the above clause, the factoring company might not make you cough up the cash; rather, they will “charge” or debit your reserve account. Meaning, any money of yours the factoring company is holding in reserve, they will take for themselves. Effectively, you still have to pay them.

Now compare that with language from a non-recourse contract. See if you can note the difference(s):

Upon written notice to Purchaser at any time that any Approved Receivable remains unpaid for more than ninety (90) days, Seller may repurchase such Approved Receivable for an amount equal to the sum of…

The language here indicates that the option remains with the you, the original seller. With this language, the factoring company cannot simply “put” the receivable back to you if the invoice doesn’t get paid. The language of the clause is silent on instances where you would have to repay. Basically the risks discussed above – refusal to pay, late payment or insolvency of your clients – are being assumed by the factoring company.

#3. Summary and Tips

• Look for the recourse language and the repurchase language – that’s it. Arguably these are the two most important that distinguish non-recourse from recourse.
• The recourse language will almost always appear in the first or second clause of the contract.
• The repurchase clause, whether recourse or non-recourse, will almost always have a calculation of the repurchase amount associated with it. Read this carefully.
• IMPORTANT – Some contracts might not have recourse language in the very beginning, making it appear to be a non recourse deal. However, the repurchase clause might give the factoring company the ability to force you to repurchase the account if the invoice doesn’t pay.

This is a nifty way for factoring companies to “disguise” a recourse deal as non recourse.

And lastly, contact your attorney to thoroughly comb through any contract before signing away.

We hope you found this non recourse factoring agreement sample helpful. As always, don’t hesitate to reach out to us for assistance securing you, or reviewing, factoring deals on your behalf.

DISCLAIMER: this article is not intended as legal advice. This article is is merely an informative, hypothetical article with examples about recourse language versus a non recourse factoring agreement sample. We advise that before you sign any deal, you take this article with a grain of salt, reference your attorney, and make sure you understand the language even after your attorney has explained it to you.

 

Accounts Receivable Journal Entry: Explained

I’ll never forget in college when I took my first accounting course. The professor told us that he couldn’t tell us how many times people mixed up “Cash” and “Accounts Receivable” when doing an accounts receivable journal entry. So he stood there in front of the class room with his arms spread wide and said “here is the difference between cash and accounts receivable”. Then he moved his left hand up and said “cash – you pay me now” and then moved his right hand up and left hand down and said “accounts receivable – you pay  me later”. And he just kept repeating it and bouncing his arms:

“Cash you pay me now, accounts receivable you pay me later. Cash you pay me now. Accounts receivable you pay me later.”

He definitely beat this like a dead horse but it was a good lesson because I never forgot. And given that the two are different, so is the accounting and reporting.

Cash vs. Accounts Receivable

If you’re new to being in business for yourself, or just starting to extend favorable payment terms to clients, you may find this article helpful. After you complete a job and have been paid for it, you have to account for that transactions by booking the sale. This is simple enough – you simply will recognize an increase in cash for a corresponding increase in sales. You saw the cash come in, and if you have an increase in cash the only other possible increase is that of sales. But how do you account for the transactions or jobs you’ve completed, but have yet to be paid on? How do you account for those transactions in your Quickbooks, Xero or other accounting software?  Below are some basic accounts receivable journal entry examples and the rationale behind them. But first, let’s cover the basics.

Cash Sale Journal Entry

When you sell a product or service for cash, credit card or check (i.e. payment now), you’ll generally book it as a cash account. This journal entry is simple, debit “cash” and credit “sales” or revenue.

Rationale: a Debit (Dr.) to an asset account like “Cash” means an increase, and a credit to an income statement account like “Sales” is an increase. In order to recognize the cash received for the new sale, you would debit cash (increase) and credit Sales (another increase). This keeps debits and credits equal in size. Remember, for debits must always equal credits!

This is the first and last journal entry you must do for a cash sale. But that’s not the case with accounts receivable journal entries (note, it’s not just an entry but more than one).

Accounts Receivable Journal Entry

When you sell a product or service in exchange for a future cash payment, you effectively have “invoiced” the client. Issuing an “invoice” creates an “accounts receivable”, meaning an account that you collect on later. Because you’re not receiving cash at the time of the sale or when the service is provided, you must account for it as such:

You must book the sale when it occurs, even if you haven’t collected cash for it. Then, when you get paid on the invoice you issued, you do a second journal entry to close out the account and reflect the increase in cash:

Simple enough. Notice how the second A/R journal entry closes out the Accounts Receivable – Client 1 account. In the first entry, there was a $10,000 increase, however when the cash was collected, we increased cash $10,000 and closed out the corresponding A/R account.

If you’re current using invoice factoring, the journal entries will be slightly different. Please contact us at info [at] invoicefinancing [dot] net for assistance with how to account for those transactions.

 

Invoice Financing vs. Factoring: Which Is Best For My Business?

If you’ve done enough research, you’ve probably come by many articles that say “invoice factoring” and “invoice financing”. On the surface they may appear to be the same product but they’re quite different. However, before we get into the differences it should be noted that they do serve the same purpose. Both invoice factoring and invoice financing offer a “liquidity” source for businesses. Meaning, they can us their unpaid invoices as source of immediate cash.

Unpaid Invoices as a Liquidity Source

Invoices (a.k.a. “accounts receivable”, A/R, or simply “receivables”) have a future value in that they represent a future cash receipt from a customer or client. Your business provides services or product, and then “invoices” the client for their payment at a later date. Invoice financing and factoring allow businesses to tap into that future payment today. In this regard, they are the same. As you will learn below however, they are two different products and it’s important that you understand how.

Invoice Financing vs Factoring: Differences

The 30,000 foot view here is that invoice financing is a loan product, whereas invoice factoring is the sale of an asset (receivables) off of your balance sheet. With invoice financing, the invoices are used as “collateral” for a revolving line of credit. The receivables belong to the business owner. However with factoring, the invoices are “sold” to the factoring company; the receivables belong to the factoring company. Here is a high level comparison how both products differ, with a summary of more similarities at the very end.

Invoice Financing – “strings attached”…

• Product: Revolving Line of Credit
• Security: Receivables act as collateral
• Credit Limit: Borrowing base established
• Personal Guarantee: Very likely
• Recourse: To the business and owner
• Rates: APR as low as 5-10%

With invoice financing, the business has access to a revolving line of credit, meaning the money can be drawn and paid back on an as needed basis. A borrowing base is established, and the receivables act as collateral. The borrowing base is essentially the assets available to be leveraged for a business, and then the credit limit is a % of the borrowing base. For example, if the only non-cash assets a company has are $100,000 in receivables, the borrowing base will take into consideration this $100,000, plus other factors, to determine the credit limit the business qualifies for.

Typically, the end number is something less than $100,000 and in rare instances, may be more. Because the line of credit is actually a loan, there is a personal guarantee and interest that amounts to 5-10% per year. Additionally, if things were to go bad, the business would be liable as well so therefore the deal would be “recourse”. Requiring a personal guarantee and recourse to the business is safer for a financing company, because they have more assets to procure in the event something goes wrong (i.e. “strings attached”). Therefore, the APR is much better than with invoice factoring.

Invoice Factoring – “no strings attached”…

• Product: Sale of Receivables
• Security: Receivables act as collateral
• Credit Limit: 80% of receivables balance
• Personal Guarantee: Sometimes
• Recourse: Sometimes to business only
• Rates: Factoring fees 1-3% per month

With invoice factoring, the business receives advances against their unpaid ad revenues of up to 80%. So for example, if a company has $100,000 in receivables, they can get up to $80,000 advanced up to the time the receivables pay. These advances are considered part of the purchase price. The remainder of the purchase price is paid when the receivables are paid. True invoice factoring deals rarely have a personal guarantee associated with them. If you come across an A/R factoring deal with a personal guarantee (or a “confession of judgment” / “cognovit note”) attached to it, be very, very suspicious!

Lastly, most pure receivables factoring deals are non-recourse, meaning the factoring company assumes all of the risk that the receivables won’t pay. However some deals are recourse to the business only, which means the business is liable to make up for any non-payments (but usually, not the owner). Because of the increased risk assumed by the factoring companies with a pure factoring deal, the rates are higher. Many business owners who don’t want to assume the risk of non-payment find that a pure accounts receivable factoring facility is a better fit for them.

In sum, a “pure” A/R factoring facility is 80% advance, non-recourse to the business and no personal guarantee. The mechanics of how it works may be slightly different, but the essence of a factoring facility include (or don’t include) those three items.

Invoice Financing vs Factoring: Other Similarities

Almost all invoice funding deals require a lockbox, UCC acknowledgment/assignment (notification), and release of a reserve.

A/R Factoring Lockbox

You will often hear this term if you are shopping around for liquidity against your invoices. A lockbox is a bank account owned by the financing company that is used to collect receipt of the invoices. Sometimes it is in the name of your business, i.e. if your business and bank account names are “Joe’s Roofing” the lockbox might be “Joe’s Roofing Collections”. Most times however the lockbox remains in the name of the funding company. This method is much safer for financing company because they collect directly from your clients and don’t have to chase you down for the money. Because lockbox deals require your customers to pay a new bank account, they require “notification”.

UCC-9 Notification

Before any type of factoring deal can go through, the factor or bank will require that you send a signed letter of acknowledgment and assignment to each of your customers, with directions on how to pay the factoring company. The acknowledgment / assignment letters are written pursuant to the United Commercial Code, the law in America governing secured transactions of this sort.

The letter basically says, “I sold (or borrowed against) my unpaid invoices that I’ve issued to you, and they now belong to (or are being held as collateral by) someone else, therefore please pay them to the following bank account.” UCC notification may be an issue for some companies who don’t want their clients to know about their financing devices. If that’s a problem you face, you should look for a “non-notification” product when shopping around.

Receivables Reserve Release

When the invoices get paid by your customers into the lockbox, the financing company will be holding some of your money. Think about it – you never received the $100,000 of unpaid invoices with your line of credit or factoring facility. You only received 50-80% of it, or something less than $100,000. So when the invoices get paid, the financing company receives the balance of the purchase price, and releases that to you minus their fee.

On a factoring facility with an 80% advance, here is a quick math breakdown. You receive 80% of $100,000 up front right now ($80,000), and in 30 days when the invoice gets paid, you receive the remaining 20% ($20,000) minus the factoring fee (1-3% per month). So on a deal with a 1% factoring fee, you would pay 1% of $100,000. The factoring company is paying $99,000 for it ($80,000 up front, then $20,000 minus $1,000 = $19,000 later).

Which Is Better For My Business?

It depends on the quality of your deal. If you personally have bad credit, factoring may be your only option. If you can afford to pay 1-3% per month and don’t want to personally guarantee the deal, go with factoring. If you have solid credit / business history, and want a cheap deal, go with an invoice financing. Again, it depends on the quality of your deal and your overall risk tolerance. Do you want strings attached for a cheaper price, or not?