A factoring agreement is a contract in which a business sells its unpaid invoices to a financial company, called a factor, at a discount in exchange for immediate cash. Instead of waiting weeks or months for customers to pay, the business gets most of the invoice value upfront and the factor takes over collecting the bill. These contracts are commonly governed by Article 9 of the Uniform Commercial Code, which sets the rules for selling accounts and securing interests in business property.1General Court of Massachusetts. Massachusetts Code § 106-9-109
Who Is Involved
Three parties sit inside every factoring deal. The client is the business selling its invoices to raise cash. Under most contracts, the client has to show it actually owns the receivables and that they haven’t already been pledged to a lender or tied up by another legal claim.
The factor is the financial company buying those invoices, usually at a discount to face value. The debtor is the client’s customer, the one who owes the money. Once the debtor receives official notice of the change, they are legally required to pay the factor rather than the original business.2General Court of Massachusetts. Massachusetts Code § 106-9-406
How the Funding Works
After the agreement is signed, the business submits invoices to the factor along with proof the work was done or the goods delivered, often a bill of lading. The factor then verifies the invoice with the customer, usually by a short call or email to the customer’s accounts payable team, to confirm the shipment arrived and there’s no dispute about the bill.
Once verified, the factor sends an advance, typically 70% to 90% of the invoice value, often within one or two business days. The rest is held in a reserve account to cover things like returns or shortages. When the customer pays the invoice in full, the factor releases the reserve to the business, minus its fees.
Recourse vs. Non-Recourse
The single biggest variable in a factoring contract is who eats the loss if the customer doesn’t pay.
In a recourse agreement, that risk stays with the business. If the customer hasn’t paid within a set window, often 60 or 90 days, the factor can sell the invoice back. The business then has to either return the advance or swap in a new, valid invoice.
In a non-recourse agreement, the factor generally absorbs the loss if the customer becomes insolvent or files for bankruptcy. The protection usually stops there. If the customer refuses to pay because of a dispute over quality or delivery, that’s not covered, and the factor’s right to collect is subject to the same defenses the customer could have raised against the original business.3General Court of Massachusetts. Massachusetts Code § 106-9-404
What It Costs
The main cost is the discount rate, the fee the factor charges for advancing the money. It’s typically a small percentage of the invoice and often climbs the longer the invoice stays unpaid. Some factors use a tiered structure where the rate steps up every 30 days the bill is outstanding.
The contract usually spells out other charges as well. Common ones include:
- Wire fees for sending advances to the business’s bank account
- Credit checks on new customers
- Fees for maintaining a lockbox or payment address for customers
- Minimum-volume charges if the business doesn’t factor a set amount of invoices each month
What You’ll Need to Provide
Factors want to see that the invoices are real and collectible before they buy them. Expect to hand over an aging report showing how long each invoice has been outstanding, a Schedule of Accounts listing invoice numbers, dates, amounts, and customer names, and recent financial statements. You’ll also need to disclose any tax liens or legal judgments against the business, since those affect whether the factor is willing to fund at all.