When a business needs cash tied up in unpaid invoices, it has two structurally different options: assigning accounts receivable, meaning selling them outright to a factor, or pledging accounts receivable as collateral for a loan. Assigning transfers ownership and takes the invoices off your books. Pledging keeps ownership with you and adds debt. The choice affects your cost of capital, your balance sheet, who talks to your customers, and what happens if your business runs into trouble later.
Assigning Receivables: Selling Invoices to a Factor
An assignment is a sale. You transfer ownership of specific invoices to a factor, and the factor pays you cash. The factor then collects directly from your customers when those invoices come due.
Advance rates typically run 70% to 90% of the invoice face value, with some business-to-business arrangements reaching 95% when the underlying customers have strong credit. The factor holds the remainder in a reserve account. Once your customer pays in full, the factor releases the reserve minus its fee, usually 1% to 5% of the invoice value. Longer payment terms and weaker customer credit push fees toward the higher end.
Because factoring is a sale, it doesn’t add a liability to your balance sheet when the transaction qualifies as a true sale for accounting purposes. That’s part of the appeal for newer or fast-growing companies that can’t meet traditional bank covenants: converting a non-liquid asset into cash without booking new debt.
Recourse vs. Non-Recourse
Every factoring agreement allocates the credit risk one of two ways. Under recourse factoring, you keep the risk. If the customer doesn’t pay within a set period, the factor charges the advance back to you. This is the more common structure and the cheaper one.
Under non-recourse factoring, the factor absorbs the loss when a customer becomes insolvent. But the term is narrower than it sounds. Most non-recourse agreements cover insolvency only, not disputes, returns, or billing errors. If your customer refuses to pay because they claim the goods were defective, the factor can still charge back the invoice. Non-recourse pricing runs noticeably higher to reflect the genuine risk the factor accepts.
Pledging Receivables: Asset-Based Lending
Pledging receivables produces a loan, not a sale. You grant a lender a security interest in your accounts receivable and receive a revolving line of credit. You still own the invoices, you still collect them, and customer payments generally flow into a lender-controlled lockbox account from which the lender draws repayment.
How much you can draw at any moment is called the borrowing base. Lenders apply an advance rate to eligible receivables, commonly 70% to 85% of face value. The Office of the Comptroller of the Currency notes that some banks advance up to 90% on eligible business-to-business receivables.1Office of the Comptroller of the Currency. Asset-Based Lending Comptroller’s Handbook Not every invoice qualifies. Lenders typically exclude invoices past a certain age (often 90 days), invoices from foreign debtors, and accounts with offsetting payables.
Interest accrues only on drawn amounts, usually at a benchmark like SOFR or prime plus a spread. Facility fees and unused-line fees may also apply. Total cost is typically lower than factoring, but the reporting and compliance burden is heavier.
The Margin-Call Risk
Your borrowing base moves daily as new invoices are created and old ones are paid or written off. Lenders require regular aging reports so they can recalculate the collateral value. When eligible receivables shrink, perhaps because a big customer goes delinquent or sales slow, the borrowing base shrinks with them. If your outstanding draw now exceeds the new base, the lender demands an immediate paydown. That demand tends to arrive at exactly the moment cash is tightest.
How Each Shows Up on Your Balance Sheet
The accounting follows the legal substance. Under ASC 860, a transfer of receivables is treated as a sale only when three conditions are all met:
- The receivables are isolated from you and your creditors, even in bankruptcy.
- The factor has the unrestricted right to pledge or exchange them.
- You don’t retain the power to repurchase the receivables or compel their return.
Meet all three and the receivables come off your balance sheet, with a gain or loss recognized on the difference between carrying value and proceeds. Fail any one and the transaction is recorded as a secured borrowing: the receivables stay on your books as an asset, and the cash you received is booked as a liability. That distinction moves your debt-to-equity ratio and can affect covenants in other agreements.
Pledging is always recorded as debt. The receivables remain on the balance sheet, and the drawn amount appears as a liability. There’s no sale question to resolve because no sale occurred.
The UCC-1 Filing Both Structures Require
Both transactions fall under Article 9 of the Uniform Commercial Code, which governs security interests in personal property across all 50 states. Critically, Article 9 applies not just to pledged collateral but also to outright sales of accounts receivable.2Legal Information Institute. UCC 9-109 – Scope A factor buying your invoices follows the same filing rules as a lender taking a security interest in them.
To make its interest enforceable against other creditors, the factor or lender must perfect the interest by filing a UCC-1 financing statement.3Legal Information Institute. UCC 9-310 – When Filing Required to Perfect Security Interest or Agricultural Lien The filing goes to the Secretary of State in the state where your business is legally organized, not where it operates. A Delaware LLC doing business in Texas files in Delaware.
Before any funder advances money, a UCC search will be run against your business. If a prior creditor has already perfected an interest in your receivables, that senior claim generally takes priority. The rule under Article 9 is first to file or perfect, and a perfected interest always beats an unperfected one regardless of timing.4Legal Information Institute. UCC 9-322 – Priorities Among Conflicting Security Interests Practical consequence for you: if you already have a lender with a blanket lien on receivables, a new factor or ABL lender will likely require that lien to be released or subordinated before funding.
Anti-Assignment Language in Customer Contracts
Many commercial contracts include clauses that prohibit assignment of the receivable or require the customer’s consent. Business owners sometimes assume these clauses block factoring. They generally don’t.
Under UCC ยง 9-406(d), contractual terms that restrict or prohibit the assignment of accounts receivable are ineffective, as are terms that treat an assignment as a default or breach.5Legal Information Institute. UCC 9-406 – Discharge of Account Debtor; Notification of Assignment Narrow exceptions apply, including sales of payment intangibles or promissory notes, health-care-insurance receivables, and obligations incurred primarily for personal or household purposes. For standard B2B invoices, anti-assignment clauses have no legal effect.
Recharacterization Risk If Your Business Files for Bankruptcy
This is the risk in factoring that most business owners never hear about, and it can rewrite the outcome of an insolvency.
A factoring transaction is documented as a sale. If your business later files for bankruptcy, the bankruptcy court can examine whether it was really a sale or a loan dressed up as one. Courts have the power to recharacterize a purported sale as a secured loan when the substance looks more like lending than purchasing.
Hold up as a true sale and the receivables belong to the factor. They aren’t part of your bankruptcy estate, and the factor keeps what it bought. Get recharacterized and the receivables snap back into the estate, become subject to the automatic stay, and the factor drops into line with other secured creditors.
Courts look at how much risk the factor actually assumed, whether you were obligated to buy back unpaid invoices, whether the factor had full dominion over the receivables, and whether the pricing looked more like a discount on a purchased asset or interest on a loan. Heavy recourse provisions are the biggest red flag. When a “sale” requires the seller to repurchase everything that doesn’t get paid, courts reasonably ask whether anything was sold at all. Non-recourse arrangements with genuine risk transfer are far more likely to survive a recharacterization challenge.
Choosing Between Assigning and Pledging
The differences between the two structures affect daily operations in ways that aren’t obvious until you’re living with the arrangement.
- Ownership: the factor owns purchased receivables; in ABL you keep ownership and pledge them.
- Customer awareness: factoring is often “notified,” so customers are told to pay the factor directly. ABL is typically non-notification unless you default, at which point the lender can instruct customers to pay it instead.
- Collections: the factor collects purchased invoices. Under ABL you collect and deposit into the lender’s lockbox.
- Credit risk: non-recourse factoring shifts customer-insolvency risk to the factor. Under ABL you always carry the credit risk, and bad receivables just reduce your borrowing base.
- Reporting burden: ABL requires aging schedules, borrowing base certificates, and often monthly or weekly financial reporting. Factoring involves less ongoing reporting, though factors verify individual invoices before buying them.
- Cost: factoring charges a flat fee per invoice, usually 1% to 5%. ABL charges interest on drawn amounts plus possible facility fees. For a business with strong credit and stable receivables, ABL is almost always cheaper. Factoring fills the gap for businesses that need speed, simplicity, or can’t qualify for bank lending.
Contract Terms to Read Before Signing
Both structures contain provisions that can trap an unwary business owner.
Factoring contracts commonly include automatic renewal clauses. Miss the written-notice window, typically 30 to 90 days before the renewal date, and the contract rolls forward for another term. Early termination fees are standard, often calculated as 2% to 5% of annual factoring volume multiplied by the remaining months. On a $100,000 monthly volume with a 2% early termination fee and six months left, walking away costs roughly $12,000.
ABL agreements carry different traps. Financial covenants like minimum fixed-charge coverage ratios can look easy at signing and bind hard exactly when the business is struggling. Lockbox arrangements give the lender practical control over your cash flow, and most facilities include a dominion trigger that lets the lender sweep the lockbox daily if performance deteriorates.
In both cases, read the default provisions carefully. The list of events that constitute default is often broader than expected, reaching changes in ownership, loss of a major customer, or adverse judgments unrelated to your payment performance on the facility itself.