A key differentiator of Factoring is that the finance provider advances funds and is then usually responsible for managing the debtor portfolio and collecting the underlying receivables, often also offering protection against the insolvency of the buyer, which may be protected by credit insurance. Indeed, by international convention, known as UNIDROIT (1988), Factoring is traditionally associated with functions beyond pure financing to include collection of receivables, debtor management, and protection against default by debtors.

In Factoring, ownership of the receivable lies with the finance provider and the buyer settles the invoice with the finance provider, not with the seller. Factoring is normally disclosed to the buyer. Factoring is provided with or without recourse depending on aspects such as credit insurance, jurisdiction and market practice. There are multiple variations of Factoring which are separately described, below.

Factoring is usually offered by specialised finance providers operating as factors, explicitly targeting the receivables financing market and serving a wide array of supplier companies including small and medium sized enterprises (SMEs). Factoring has also been extended to large value transactions. Factors may also offer Receivables Discounting services.

A factoring agreement is entered into between the seller (as client), and the finance provider under which the seller provides the finance provider with an assignment of rights (or transfer of title or the equivalent) to the asset(s) being financed, according to the jurisdiction in question. Notice of assignment is usually provided to the buyer; a certified copy of the invoice or the invoice data set is provided to the finance provider. Any additional security is suitably documented.

• Default or insolvency of the buyers, including relevant country risk, mitigated by credit and risk assessment, monitoring and potentially credit insurance
• Existence of valid and eligible invoices being factored, mitigated by a regime of sampling and in some cases individual verification
• Concentration risk mitigated by setting concentration limit thus spreading the risk over the sales ledger
• Factorability of the receivables – transaction characteristics, contract or financing terms that adversely impact the ability to factor, such as long warranties that the seller has to provide, contractual businesses (such as construction), the sale of perishable goods or the presence of stage payments. In general, the finance provider will exclude prohibited and restrictive categories of goods
• Receivables dilutions (for example, credit notes, offsets against invoices due for payment), mitigated by the security margin and advance ratio, through the establishment of a reserve (or margin) against the eligible discounted receivables
• Pre-existing security arrangements or bans on assignments, mitigated by waivers given by other secured parties or their removal or by taking additional security and completing the required perfection requirements
• Party-related risk mitigated by KYC/AML handled during the on-boarding procedures and subsequently in periodic reviewsLack of legal authority, mitigated by legal due diligence on the respective jurisdictions and the involved contractual parties
• Counter-trading mitigated by regular verification that the balance outstanding with the finance provider matches that on the buyer’s records
• Risks arising in the event of insolvency of the seller, such as ‘claw-back’, where a finance provider is aware of distress at the time of a receivable purchase, or in the case of co-mingling of funds in a general bank account. For the latter, there is mitigation through the use of a collection account in the name of the finance provider
• Fraud by the seller, for example by inflating the value of invoices or offering invoices without an underlying commercial transaction, mitigated by verification of the transaction and strong credit controls
• Double financing, mitigated by obtaining a security interest in the receivables, applying appropriate KYC procedures and perfecting the assignment of rights to the receivable
• Fraud by collusion between seller and one or more of its buyers leading to diversion of funds from meeting maturing obligations, mitigated by monitoring the financial health and management integrity of the client through maintaining contact and receiving regular management information to look for signs of a deterioration of the business and suspicious circumstances, and also mitigated, where necessary, by direct collections on the part of the finance provider
• Fraud by collusion between the seller and an employee of the finance provider, mitigated by internal controls and segregation of duties
• General operational risks resulting from multiple operational requirements to perfect ownership of receivables and undertake ongoing administration, mitigated by sound procedures, appropriate levels of automation and process controls
• Risks arising from incomplete or faulty perfection of jurisdictional requirements for assignments of title, particularly in a cross-border context, mitigated by appropriate due diligence.

All the above risks are also mitigated by a robust audit process of transactions, systems and controls and by regular reporting and monitoring, based on due diligence.

Source: Global SCF Forum

• Growth of business for the seller on open account terms
• Credit risk coverage in non-recourse factoring as the finance provider will pay normally 100% of the credit covered receivables if the buyer defaults in its payment
• Working capital optimisation for the seller without increasing balance sheet leverage (subject to accounting treatment in the relevant jurisdiction)
• Improved payment terms for the seller
• Finance and liquidity availability for sellers with limited credit availability from traditional banking sources
• Sales ledger management and collection of receivables as part of the service frees up the seller’s resources, and may offer improved debtor management
• Improved stability of the supply chain and reduced risk of supply chain disruption.

Confidential or Non-Notification/Disclosed; Domestic/International; Recourse/Non-recourse; Whole Turnover/Selective.

The buyer is situated in the same country as the seller. Country-specific rules or regulations may apply due to the domestic character of the transaction which would affect the relationship between the finance provider, the buyer and the seller.

The finance provider has recourse to the seller in the case of buyer default.

The invoice bears no notice of assignment and the buyer is not aware of the factoring agreement between the seller and the finance provider.

The debt verification is carried out by the finance provider in the name of the seller so that the buyer is not aware of the factoring agreement. The buyer typically pays the outstanding invoice into a ‘trust’ or ‘escrow’ account. In some cases, the buyer may pay funds into a normal current account in the name of the seller, who acts as a collecting agent on behalf of the finance provider and undertakes to forward the funds immediately after collection to the same finance provider.

In Selective Factoring, the seller or finance provider selects a range of invoices to be assigned to the finance provider, identifiable by a common feature, such as buyer name, governing law of the receivables, and production segment among others. Spot factoring involves the factoring of an individual invoice.