That is, are they creditworthy? (A factor may actually obtain insurance against the debtor’s becoming bankrupt and thus the invoice not being paid.)
The factor is willing to consider purchasing invoices from all the invoice seller’s creditworthy debtors.
The classic arrangement which suits most small firms, particularly new ones, is full service factoring where the debtor is notified to pay the factor {notification} who also takes responsibility for collection of payments from the debtor and the risk of the debtor not paying in the event the debtor becomes insolvent, non recourse factoring.
This traditional method of factoring puts the risk of non-payment fully on the factor.
If the debtor cannot pay the invoice due to insolvency, it is the factor's problem to deal with and the factor cannot seek payment from the seller. The factor will only purchase solid credit worthy invoices and often turns away average credit quality customers.
The cost is typically higher with this factoring process because the factor assumes a greater risk and provides credit checking and payment collection services as part of the overall package.
For firms with formal management structures such as a Board of Directors (with outside members), and a Controller (with a professional designation), debtors may not be notified (i.e., non-notification factoring).
The invoice seller may not retain the credit control function.
If they do then it is likely that the factor will insist on recourse against the seller if the invoice is not paid after an agreed upon elapse of time, typically 60 or 90 days.
In the event of non-payment by the customer, the seller must buy back the invoice with another credit worthy invoice. Recourse factoring is typically the lowest cost for the seller because they retain the bad debt risk, which makes the arrangement less risky for the factor.
Despite the fact that most large organizations have in place processes to deal with suppliers who use third party financing arrangements incorporating direct contact with them, many entrepreneurs remain very concerned about notification of their clients.
It is a part of the invoice selling process that benefits from salesmanship on the part of the factor and their client in its conduct.
Even so, in some industries there is a perception that a business that factors its debts is in financial distress.
