A factoring agreement is a contract in which a business sells its unpaid customer invoices to a financial company, called a factor, in exchange for immediate cash. Instead of waiting 30, 60, or 90 days for customers to pay, the business gets most of the invoice value upfront and the factor takes over collecting the balance. These contracts are commonly treated as sales of accounts under Article 9 of the Uniform Commercial Code, though the precise legal status depends on the contract terms and local law.1General Court of Massachusetts. Massachusetts Code § 106-9-109
Who the Three Parties Are
Every factoring arrangement involves three parties. The client is the business selling its invoices to free up cash. The factor is the financial company buying those invoices, usually at a discount. The debtor is the client’s customer, the one who actually owes the money for goods or services received.
The client has to be able to show it owns the invoices outright and hasn’t already pledged them to another lender or let them become subject to other legal claims. One point about the debtor often trips people up: the customer is only legally obligated to pay the factor after receiving formal notice of the assignment. Until that notice arrives, a payment made to the original business still discharges the debt.2General Court of Massachusetts. Massachusetts Code § 106-9-406
How the Funding Actually Works
Once the agreement is signed, the business submits invoices as it generates them, together with proof that the work was done or the goods were delivered. The factor then verifies the invoice with the customer, often through a short call or email to the customer’s payables department, to confirm receipt and check for any disputes.
After verification, the factor sends an advance, typically 70% to 90% of the invoice value, usually within one or two business days. The remainder goes into a reserve account the factor holds back to cover possible returns, shortages, or other adjustments. When the customer eventually pays the invoice in full, the factor releases the reserve to the business and deducts its fees.
Recourse vs. Non-Recourse Agreements
The biggest structural question in any factoring contract is who absorbs 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 hand the invoice back. The business then either repays the advance or substitutes a new, valid invoice of equivalent value.
In a non-recourse agreement, the factor generally absorbs the loss when a customer becomes insolvent or files for bankruptcy. The protection is narrower than it sounds: it usually does not cover a customer who refuses to pay because of a dispute over the goods or services. Either way, the factor’s right to collect is subject to the same defenses and claims the customer could have raised against the original business.3General Court of Massachusetts. Massachusetts Code § 106-9-404 A quality dispute or a billing error travels with the invoice.
What It Costs
The main cost is the discount rate, a percentage of the invoice value that the factor keeps as its fee. The rate often climbs the longer the invoice stays unpaid. Some factors use a tiered schedule that steps up every 30 days the bill is outstanding, which is how the factor gets paid for the time it takes to collect.
Several smaller charges usually sit alongside the discount rate, and they add up:
- Wire fees for sending advances to the business’s bank account
- Credit checks on new customers
- Account maintenance fees, including any mailing address or lockbox the factor sets up for customer payments
- Minimum volume fees if the business doesn’t factor a certain dollar amount of invoices each month
What the Business Has to Provide
Before funding, the factor needs enough information to judge whether the invoices will actually get paid. That generally means 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 such as a profit and loss statement and balance sheet. Payment history or credit information on the customers themselves is also standard.
The business also has to disclose tax liens, judgments, or other legal claims against it, since those can attach to the receivables and change the factor’s position. If the paperwork and the customer credit check hold up, funding can start on the first eligible invoice within a couple of days.