Definitive Guide to Factoring Agreement Terms and Clauses

Seven in ten people admit to signing a contract without knowing all the details, according to Adobe research. While that approach may work fine when you’re signing up for the rewards program at your local coffee shop, it’s not a great approach when you’re getting established with a factoring company. Knowing key terms in factoring agreements makes it easier to have the contract tailored to your needs, so you can set your business up for long-term success. In this guide, we’ll walk you through common factoring terms and clauses, explain what they really mean, and highlight alternatives that can help you secure the best possible terms for your business.

Note: While this guide can help you understand factoring contracts and some of the legal considerations in factoring, it should not be taken as legal advice. Consult an attorney if you have questions.

Key Factoring Terms and Clauses to Watch For

When you enter a factoring agreement, you are committing to specific terms that will impact your business’s cash flow, customer relationships, and financial flexibility. Every factoring company structures its agreements differently, so it is essential to understand what each clause means before signing.

Some terms are straightforward, while others have nuances that could cost your business money if overlooked. Below, we will break down the most important terms and clauses.

Factoring Advance Rate and Holdback: How Much Cash You Get Upfront

One of the most critical elements of a factoring agreement is how much money you receive when you sell an invoice. This is determined by two key numbers:

• Advance Rate: The percentage of the invoice amount you receive immediately.
• Holdback (or Reserve): The portion the factoring company holds until your customer pays.

For example, if your factor offers an 85 percent advance rate, you will receive 85 dollars upfront for every 100-dollar invoice you submit. The remaining 15 dollars is held back and released once your customer pays, minus any fees.

What Affects Your Advance Rate

Your business will not always get the highest possible advance rate. Factoring companies assess several factors when determining how much they are willing to advance, including:

• Industry Risk: It’s common for businesses in industries like trucking, staffing, and construction to see different advance rates due to risk levels.
• Customer Creditworthiness: If your customers have a strong payment history, your advance rate may be higher.
• Factoring Type: Recourse factoring (where you remain liable for non-payment) typically offers higher advances than non-recourse factoring.
• Reserve Requirements: Some factors hold a larger reserve to cover potential disputes or chargebacks.

Typical Advance Rates

Advance rates in Canada generally range from 75 to 95 percent, depending on the industry and risk factors. For example:

• Trucking and Freight Factoring: Often 90 to 96 percent, since freight invoices are relatively low-risk.
• Staffing Factoring: Typically 90 to 92 percent, depending on customer payment history.
• Construction Factoring: Lower, around 70 to 80 percent, due to long payment cycles and lien risks.

Recourse vs. Non-Recourse Factoring: Who Takes the Risk When Customers Do Not Pay

In the last section, we touched on how recourse factoring typically offers higher advance rates than non-recourse factoring. That is because of a fundamental difference in who is responsible for unpaid invoices.

When you factor invoices, you are not just selling them. You are also deciding who takes the financial hit if your customer does not pay. This is one of the most critical factoring clauses, and misunderstanding it can lead to unexpected costs.

Recourse Factoring: You Are Liable for Non-Payment

With recourse factoring, your business remains responsible for invoices that your customers fail to pay. If a customer does not settle their invoice within a set period, often 60 to 90 days, you must buy it back or replace it with another invoice of equal value.

• Why Businesses Choose It: Lower fees, higher advance rates, and greater flexibility.
• What to Watch For: Clear terms on when you must repurchase invoices and how disputes are handled.

For example, a Vancouver trucking company factors a $10,000 invoice with a 90 percent advance rate. The factor advances $9,000, holding back $1,000. If the customer fails to pay after 90 days, the company must return the $9,000 or provide another invoice of equal value.

Non-Recourse Factoring: The Factor Absorbs the Risk

With non-recourse factoring, the factoring company takes on the risk of customer non-payment, but only under specific conditions. Many factors only cover non-payment due to customer insolvency, such as bankruptcy, not for reasons like disputes, fraud, or slow payment.

• Why Businesses Choose It: Protection from bad debts, less financial risk.
• What to Watch For: Narrow definitions of “non-recourse.” Some agreements only apply if a customer officially declares bankruptcy, leaving you responsible for other types of non-payment.

For example, a Toronto wholesaler factors a $20,000 invoice with an 80 percent advance rate. The factor advances $16,000. If the customer declares bankruptcy, the factor absorbs the loss, and the business keeps the funds. But if the customer simply stalls payment, the business may still be responsible.

Which Option is Best for Your Business

• Recourse Factoring: Ideal if your customers have strong payment histories and you want to maximize cash flow with higher advance rates and lower fees.
• Non-Recourse Factoring: Works well if you want protection against customer insolvency, but expect lower advances and higher fees.

Fees and Costs: Understanding the True Cost of Factoring

Every factoring company structures its fees differently, and small details in your agreement can add up over time. Some fees are expected, while others may be hidden in the fine print. Understanding how fees are structured will help you understand the cost of factoring and compare factoring companies to ensure you are not paying more than necessary.

Discount Rate: The Primary Cost of Factoring

The discount rate, sometimes called the factoring fee, is the percentage the factoring company charges for advancing funds. This fee is typically calculated per invoice and depends on factors such as industry risk, customer creditworthiness, and payment timelines.

• Typical Range: One to five percent per 30 days (lower for stable industries, higher for riskier ones).
• Flat vs. Tiered Structure: Some factors charge a flat rate per invoice, while others use a tiered structure where the fee increases if your customer takes longer to pay.

For example, a Montreal business factoring a $50,000 invoice at a three percent discount rate will pay $1,500 in fees. If the agreement is tiered and the customer takes 60 days to pay, the cost could double to $3,000.

Additional Fees to Watch For

Beyond the discount rate, factoring agreements often include other fees that may not be immediately obvious.

• Wire Transfer Fees: Some factors charge $10 to $50 per transfer, while others offer free ACH deposits but charge for same-day funding.
• Monthly Minimum Fees: If your agreement has minimum volume requirements, you may pay penalties if you do not factor enough invoices.
• Credit Check Fees: Some factors charge per customer credit check, while others include this in their service.
• Termination Fees: Exiting a contract early may result in substantial penalties, depending on your agreement.
• Reserve Release Fees: Some factors charge a small percentage to release the holdback, reducing the final payout.

How to Avoid Overpaying

• Compare Discount Rates and Fee Structures: Some factors offer lower rates but make up for it with extra fees.
• Ask About Hidden Fees: Request a full fee breakdown before signing.
• Negotiate Terms: Many fees are flexible, especially if you have strong financials or a high factoring volume.

Contract Length and Termination Clauses: How Long Are You Locked In

Factoring agreements are not always flexible. Some providers allow businesses to factor invoices as needed, while others require a long-term commitment. Understanding the contract length and termination terms is essential to avoiding unexpected penalties and ensuring the agreement works for your business long term.

Types of Factoring Agreements

• Spot Factoring: You factor invoices on an as-needed basis with no long-term commitment.
• Short-Term Contracts: These agreements typically last three to twelve months and offer some flexibility.
• Long-Term Contracts: Some factors require a one- to three-year commitment, often with penalties for early termination.

Many factoring companies favour annual agreements with automatic renewal clauses, meaning you must actively cancel the contract before the renewal date to avoid being locked in for another term.

Early Termination Clauses: What Happens if You Want to Leave

If your business no longer needs factoring or finds a better offer, you may want to end your agreement early. However, many factoring contracts include termination penalties or buyout fees to discourage early exits.

• Flat Buyout Fees: A fixed amount required to exit the agreement early.
• Percentage-Based Fees: A penalty based on the remaining contract value, such as two percent of expected volume.
• Notice Period Requirements: Some agreements require 30 to 90 days’ notice before cancellation.

For example, if your business signed a 12-month contract with a required factoring volume of $500,000 per year and the early termination fee is two percent of the remaining volume, cancelling after six months could cost you $5,000.

Minimum Volume Requirements: Are You Required to Factor a Certain Amount

Some factoring agreements include a minimum volume requirement, meaning your business must factor a specific dollar amount or number of invoices within a set period. If you do not meet the requirement, you may face penalties, additional fees, or even higher factoring rates.

How Minimum Factoring Volume Requirements Work

Factoring companies use volume requirements to ensure a consistent revenue stream. These factoring agreement clauses typically appear in long-term contracts and can be structured in different ways:

• Monthly Minimums: You must factor a certain amount per month, such as $50,000 in invoices.
• Annual Minimums: You must factor a total of X dollars per year, regardless of monthly variations.
• Per-Invoice Minimums: Some agreements require factoring every invoice from specific customers.

For example, if your agreement includes a $100,000 monthly minimum and your business only factors $75,000 in invoices, you may have to pay fees on the missing $25,000 or cover the difference in factoring fees.

Penalties for Not Meeting Minimums

Failure to meet the agreed volume can trigger:

• Penalty Fees: A flat charge or percentage of the shortfall, such as one percent of the missing amount.
• Higher Factoring Fees: Some providers increase your discount rate if you fall short.
• Contract Extensions: You may be required to continue factoring beyond the original term to make up for lost volume.

For example, if your factoring company charges a three percent fee on factored invoices but increases it to four percent if you do not meet the minimum, your cost of factoring could rise significantly.

How to Avoid Getting Locked into Minimums

• Look for Flexible Agreements: Some factoring companies offer no-minimum contracts, especially for small businesses.
• Negotiate Lower Minimums: If required, push for a lower threshold that aligns with your cash flow needs.
• Choose Spot Factoring If Possible: As mentioned, this option lets you factor invoices only when needed, without volume commitments.

Debtor Creditworthiness: How Your Customers Affect Your Factoring Terms

The creditworthiness of your customers will be assessed before invoices are approved for funding as part of factoring risk management strategies. Since the factor relies on your customers to pay, their ability to settle invoices on time directly impacts your advance rate, fees, and eligibility for factoring.

How Factoring Companies Assess Customer Creditworthiness

Before funding an invoice, the factoring company will conduct a credit check on your customer (the debtor) to determine their payment reliability. Key factors include:

• Payment History: How consistently the customer pays their invoices on time.
• Credit Score and Financial Health: Larger customers may have a business credit rating, while smaller ones may require additional financial records.
• Industry Risk: Customers in volatile industries may be considered higher risk, leading to lower advance rates.
• Outstanding Debt: If a customer has significant outstanding invoices, the factor may limit funding.

For example, if you sell to large retailers with strong credit ratings, you may qualify for a higher advance rate and lower fees. However, if your customers have a history of late payments or financial instability, the factor may require higher reserves or additional fees to offset the risk.

What Happens If Your Customer’s Credit is Poor

If a factoring company determines that your customer is a high credit risk, they may:

• Reject the Invoice Entirely: The factor may refuse to fund invoices from customers with poor payment history.
• Offer a Lower Advance Rate: Instead of a 90 percent advance, you may only receive 75 percent to offset the risk.
• Charge a Higher Discount Rate: The factor may increase fees to account for the increased likelihood of delayed payments.
• Require Additional Reserves: A larger portion of the invoice may be held back until the customer pays.

How to Ensure Your Customers Are Factoring-Eligible

• Check Customer Credit Before Extending Payment Terms: Request a business credit report or verify payment history.
• Work With Reliable Customers: Factoring works best when dealing with financially stable clients who pay on time.

Notification vs. Non-Notification Factoring: Will Your Customers Know

Factoring agreements outline whether your customers will be notified that their invoices have been sold to a factoring company. This distinction affects how payments are handled, how customers perceive your business, and what level of control you maintain over customer interactions.

Notification Factoring: Customers Are Informed

With notification factoring, your customers receive a formal notice stating that their invoices have been assigned to a factoring company. Payments are made directly to the factor, not to your business.

• Why Factors Prefer It: Since payments go directly to them, there is a lower risk of delayed or misdirected funds.
• Impact on Your Business: You must discuss the change with your customers before it happens to ensure they understand that it helps you provide them with longer payment terms and improves your service.

For example, if a staffing agency factors invoices under a notification agreement, clients will receive payment instructions from the factor and may need to update their records to send payments to the new account.

Non-Notification Factoring: Customers Are Not Informed

With non-notification factoring, your customers do not know that invoices are being factored. Payments still go through your business, but behind the scenes, the factor advances funds based on those invoices.

• Why Businesses Sometimes Prefer It: Maintains a seamless customer relationship without outside interference.
• What to Watch For: Higher fees and stricter approval requirements, since factors take on more risk.

For example, a manufacturing company using non-notification factoring will continue receiving payments from customers, then pass those payments to the factoring company without disclosing the arrangement.

Which Option is Best for Your Business

• Choose Notification Factoring if you are comfortable with customers knowing about the arrangement and want lower fees.
• Choose Non-Notification Factoring if maintaining direct customer relationships is a priority, but expect slightly higher costs.

Reserve Accounts and Adjustments: How Factoring Companies Hold and Release Funds

When you factor an invoice, you do not always receive the full amount upfront. A portion of the invoice called the “reserve” is held back by the factoring company and later released, minus any deductions. Understanding how reserve accounts work is critical because they impact your cash flow timing and total payout.

How Reserve Accounts Work

• Reserve Percentage: The portion of the invoice the factoring company holds back, often ranging from five to 20 percent.
• Release Timing: Reserves are typically released once the customer pays in full, but some factors impose waiting periods.
• Deductions: If there are disputes, chargebacks, or adjustments, the factoring company may deduct from the reserve before releasing funds.

For example, if your business factors a $50,000 invoice with a 90 percent advance rate and a ten percent reserve, you receive $45,000 upfront. Once your customer pays, the factor releases the remaining $5,000 minus any applicable fees or deductions.

Why Factoring Companies Hold Reserves

Factoring companies use reserve accounts to protect against risks, such as:

• Customer Disputes: If a customer refuses to pay due to billing errors, defective goods, or contract disputes, the reserve may be used to cover the shortfall.
• Late Payments: If an invoice is paid beyond the agreed timeframe, additional fees may be deducted before the reserve is released.
• Chargebacks or Offsets: If your business has other unpaid obligations with the factor, they may deduct funds from the reserve to cover those costs.

Adjustments That Can Impact Your Reserve

• Early Payment Discounts: If your customer pays early and takes a prompt payment discount, the factor may reduce the final payout.
• Dispute-Related Deductions: If your customer contests part of the invoice, the factor may withhold funds until the issue is resolved.
• Volume-Based Adjustments: Some factoring companies adjust advance rates and reserves based on monthly or annual volume thresholds.

For example, if your reserve is ten percent but the customer disputes a $5,000 charge on a $50,000 invoice, the factoring company may withhold that portion of the reserve until the dispute is resolved.

Dispute Resolution: How Factoring Companies Handle Invoice Issues

Factoring agreements outline how disputes, whether between you and the factoring company or between your customer and the factor, are resolved. These clauses determine who is responsible for unpaid invoices, how disputes impact payouts, and what legal options you have if conflicts arise.

How Disputes Affect Factored Invoices

If a customer disputes an invoice, the factoring company may withhold funds, charge fees, or even require you to buy back the invoice. Common dispute scenarios include:

• Billing Errors: Incorrect amounts, duplicate charges, or missing details on invoices.
• Quality or Service Complaints: Customers refusing to pay due to dissatisfaction with goods or services.
• Contract Disputes: Disagreements over contract terms or performance obligations.

For example, if a construction supplier factors a $25,000 invoice and the customer disputes a $5,000 charge, the factor may withhold that portion of the reserve until the issue is resolved or even reject the invoice altogether.

Factoring Company Dispute Policies

Factors handle disputes in different ways. Your agreement should outline:

• How Long the Factor Will Hold Disputed Funds: Some factors immediately withhold reserves when a dispute arises, while others allow time to resolve issues before adjusting payouts.
• Who is Responsible for Resolving the Dispute: You may be required to negotiate directly with your customer, or the factor may intervene.
• Recourse Obligations: If the dispute is not resolved within a set timeframe), you may be required to buy back the invoice or replace it with another one.

Legal Dispute Resolution with the Factoring Company

Beyond customer disputes, you should also review how conflicts between you and the factoring company are handled. Most agreements specify:

• Governing Law: Which province’s contract laws apply.
• Arbitration vs. Litigation: Some contracts require disputes to be settled through arbitration rather than going to court.
• Termination Rights: If disputes arise frequently, you may want to exit the agreement early, but termination clauses may limit this option.
• Exclusivity Clauses: Whether you can work with multiple factoring companies or are locked into one provider.

Exclusivity Clauses: How Your Factor’s PPSA Registration Affects Your Flexibility

Most factoring agreements in Canada include a Personal Property Security Act (PPSA) registration. This registration secures the factoring company’s interest in your receivables, making it nearly impossible to work with another factor without the first factor’s approval.

How PPSA Registrations Work in Factoring

• The Factoring Company Registers a Security Interest in Your Receivables: This gives them the legal right to collect payments before any other creditor and prevents your receivables from being used as collateral elsewhere.
• It Prevents You from Using Multiple Factors or Lenders: Even if your contract does not explicitly say you must factor all invoices with the same provider, the PPSA registration effectively locks you in unless the factor agrees to remove or subordinate their claim.
• It Blocks Receivables as Collateral for Other Financing: Since the factor holds a first-position security interest in your receivables, you cannot use them to secure a business loan or line of credit unless the factor agrees.
• It Must Be Cleared Before You Can Switch Providers: To move to another factoring company or free up your receivables, the original factor must release the PPSA registration, which usually requires full repayment of outstanding advances plus any termination fees.

For example, if a freight company factors invoices with Company A, their PPSA registration prevents a bank from accepting those receivables as collateral for a loan. Even if the business no longer wants to factor, the PPSA remains in place until the factor officially removes it.

Are There Any Non-Exclusive Factoring Options?

While true non-exclusivity is rare due to PPSA registrations, some providers offer:

• Selective Factoring Agreements: Where you only factor invoices from certain customers or business lines.
• Flexible Exit Clauses: Some agreements allow easier termination if you meet specific conditions.
• PPSA Subordination: Some factors may agree to share priority with other lenders, but this is uncommon.

Pitfalls and Red Flags in Factoring Agreements: What to Watch For

While most factors operate transparently, some agreements include hidden fees, restrictive terms, or unfair risk shifting that could leave your business in a difficult financial position. Here are some of the biggest red flags to watch for before signing a contract.

Unclear Fee Structures or Unexpected Charges

Some factors advertise low discount rates but bury additional fees in the fine print, such as administrative fees, wire transfer fees, or reserve release fees. Always request a full breakdown of costs before signing.

Overly Restrictive Termination Clauses

Factoring should provide financial flexibility, but some contracts make it difficult or expensive to leave, requiring long notice periods, termination penalties, or minimum volume buyouts before they release their PPSA registration.

Fine Print That Shifts Too Much Risk onto Your Business

If an agreement limits the factor’s liability while still holding you responsible for customer non-payment, disputes, or invoice buybacks, it may leave your business exposed to excessive financial risk. Be cautious of non-recourse factoring agreements that only cover bankruptcy but exclude all other non-payment scenarios.

Negotiating a Fair Agreement: How to Get Favorable Factoring Terms for Your Business

Factoring agreements are not set in stone. While some terms are standard, many clauses, including fees, contract length, reserve percentages, and termination conditions, are negotiable. Taking the time to compare providers and push for better terms can help ensure that factoring works in your favour.

How to Compare Factoring Providers

• Look Beyond the Discount Rate: A lower rate does not always mean a better deal. Consider hidden fees, reserve requirements, and factoring contract terms before making a decision.
• Evaluate Customer Service and Transparency: A factor that is difficult to communicate with before signing will likely be even harder to deal with after you are locked into a contract.
• Check PPSA Policies and Exit Terms: Since most Canadian factoring agreements involve PPSA registrations, make sure you understand how and when the factor will release their claim on your receivables.

Key Areas Where You Can Negotiate

• Advance Rate and Reserve Percentage: Higher advances and lower reserves improve your immediate cash flow.
• Discount Rate and Additional Fees: Ask for a clear breakdown of fees and push back on unnecessary charges.
• Contract Length and Termination Fees: Request a shorter-term contract or flexible exit clause to avoid long-term commitments.
• Minimum Volume Requirements: If you do not need to factor every month, ask for a lower minimum or a contract without volume commitments.

Find Out Your Personalized Factoring Terms

Now that you’re familiar with the factoring agreement essentials, the next step is finding a factoring provider who can establish a contract that works for both of you, so you can start accelerating your cash flow right away. We can streamline your search by matching you with trusted factoring partners who understand your unique situation. To speak with a factoring specialist, request a complimentary rate quote.

FAQs on Factoring Agreement Terms