Factoring can be a valuable financing solution for small and medium-sized businesses (SMBs) looking to improve cash flow and maintain steady operations. But the finer details of factoring agreements—and especially contractual terms—can be complex and difficult to navigate. Understanding these terms is crucial to ensuring that factoring is the right fit for your business and avoiding costly surprises.

This article breaks down the key elements of a factoring contract in a clear and straightforward way, helping you make informed financial decisions with confidence.
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Disclaimer: This guide explains the key clauses in a factoring contract, so you can make an informed decision. However, this is not legal advice—consult a financial professional for specific concerns.

What is a factoring contract?

Factoring is a financial solution that helps businesses improve cash flow by selling their unpaid invoices (accounts receivable) to a factoring company. In return, the business receives an immediate cash advance, while the factor takes over the invoice collection process. 

Depending on the agreement, the factor may also assume the risk of customer non-payment (non-recourse factoring) or require the business to cover unpaid invoices (recourse factoring). More on these concepts below.

Unlike traditional bank loans, factoring provides quick access to working capital without requiring collateral beyond the receivables themselves. It’s widely used in industries with long payment cycles, such as manufacturing, transportation, and wholesale distribution.

Key clauses in a factoring contract

Your factoring contract may have particular stipulations and clauses suited to your business and industry. But most contracts should include the following.

1. Purpose of the contract

A factoring contract establishes the legal relationship between your business and the factor. It outlines the process for transferring invoices, clarifies who is responsible for collecting payments, and specifies whether the factor assumes the risk of bad debt.

Understanding these terms is crucial before signing, as they impact your company’s financial flexibility and liability in case of non-payment.

2. Eligible invoices

Not all invoices qualify for factoring. The contract will specify eligibility criteria, including:

• Certainty and payability: Only invoices from completed sales or services that are accepted by the customer can be factored.
• Business-to-business (B2B) transactions only: Most factors do not accept invoices from consumer (B2C) transactions, as they carry higher risks.
• Customer creditworthiness: The factor will assess the financial health of your customers before accepting invoices. High-risk accounts may be rejected.
• Invoice age and payment terms: Typically, invoices with payment terms between 30 and 120 days are eligible. Overdue invoices are usually not accepted.
• Geographical restrictions: Some factors operate only within specific regions or exclude high-risk countries.
• Undisputed invoices: The factor will not accept invoices that are under dispute or subject to chargebacks.

Compliance with these criteria ensures smooth financing and reduces the risk of rejected invoices, which could delay cash flow.

3. Cash advances and funding percentage

One of the main advantages of factoring is the ability to access cash quickly. But factors typically do not advance the full invoice amount upfront. Instead, they provide an initial advance, usually between 80% and 95%, while holding the remaining balance in reserve.

Once the customer pays the invoice in full, the factor releases the remaining amount after deducting fees. Some factors may also withhold a portion of the reserve to cover potential risks.

Understanding these terms is crucial to managing your business’s liquidity effectively.

4. Fees and costs

Invoice factoring comes at a cost, which varies based on factors such as industry, customer risk, and contract structure. The main charges to consider include:

• Factoring fee: A percentage of the invoice amount, covering administrative and collection costs. This can range from 0.5% to 5% per invoice, depending on the agreement.
• Discount rate: The interest charged on the cash advance. This rate is typically based on the invoice amount and duration of the advance.
• Additional fees: Some contracts include setup fees, credit check fees, termination fees, and penalties for disputed invoices.

Carefully reviewing the contract’s fee structure will help avoid unexpected costs.

5. Customer payment management

Factoring can also streamline your accounts receivable process. Depending on the agreement, the factor may handle:

• Invoice collection: The factor takes over payment reminders, follow-ups, and collection efforts.
• Debt recovery: Some factors provide collection services in case of delayed payments.
• Customer communication: In some cases, the factor interacts directly with customers, while in others, you retain control over customer relationships.

Outsourcing payment collection can free up your internal resources, but it’s important to ensure that the factor’s approach aligns with your customer service standards.

6. Recourse vs. non-recourse factoring

A crucial distinction in factoring contracts is whether they are recourse or non-recourse:

• Recourse factoring: Your business remains responsible for unpaid invoices. If the customer defaults, you must repay the factor or replace the invoice with another eligible one.
• Non-recourse factoring: The factor assumes the risk of non-payment, meaning your business is not liable for defaulted invoices. However, this option is usually more expensive.

Understanding this difference is essential when evaluating the level of risk you are willing to take.

7. Exclusivity and commitment terms

Some factoring agreements require businesses to submit all invoices to the factor (whole turnover factoring), while others allow selective invoice factoring. The contract may also include:

• Exclusivity clauses: Preventing your business from using other financing solutions during the contract term.
• Minimum volume requirements: Some factors require a minimum monthly or annual invoice volume to maintain the agreement.

Carefully consider these clauses, as they impact your financial flexibility.

8. Termination and early exit penalties

Factoring agreements are often open-ended but may require a notice period for termination. Some contracts impose penalties for early termination, especially if a minimum commitment is not met.

Key termination-related considerations include:

• Notice period: Many contracts require 30 to 90 days’ notice before cancellation.
• Exit fees: Some contracts charge a penalty if you leave before the agreed period.
• Ongoing obligations: You may need to continue factoring invoices for a certain time even after giving notice.

Reading the termination clauses carefully can help avoid unexpected costs if you decide to switch financing providers.

Should you consult an expert?

Factoring can be a powerful tool, but it is also a complex financial commitment. Seeking advice from an accountant, financial advisor, or legal expert can help you:

• Analyze contract terms and negotiate better conditions.
• Identify hidden fees and restrictive clauses.
• Compare factoring providers to find the best fit for your business.

Making an informed decision ensures you get the cash flow benefits of factoring without unnecessary financial burdens.

A faster, more flexible alternative

Traditional factoring can involve lengthy paperwork and administrative requirements. If you’re looking for a simpler, digital financing solution, Defacto offers an instant, hassle-free alternative.

With just a few clicks, you can access quick, paperless financing without the long-term commitments of traditional factoring.

Need a smarter way to manage cash flow? Try Defacto today and stay in control of your finances!