What Is an Accounts Receivable Purchase Agreement?
An accounts receivable purchase agreement is a contract between a buyer and seller. The seller sells receivables and the buyer collects the receivables.3 min read
2. What Is Accounts Receivable Financing?
3. Important Factors to Consider
An accounts receivable purchase agreement is a contract between a buyer and seller. The seller sells receivables to get cash up front, and the buyer has the right to collect the receivables from the original customer.
About Receivables Purchase Agreements
Receivables purchase agreements give a company the chance to sell off as-yet-unpaid bills, or "receivables." Buyers gain a profit-making opportunity, while sellers gain security. These types of agreements create a contractual framework for the sales of accounts receivable. A company might sell all receivables through a single agreement, or it may decide to sell an interest in its entire pool of receivables.
These agreements are often between multiple parties: one company sells its receivables, another party buys them, and additional companies serve as administrators and servicers.
During the course of business, an operating company creates accounts receivables. When it sells them to a financing company, the accounts receivable purchase agreement legalizes the process.
What Is Accounts Receivable Financing?
Accounts receivable financing is a financing arrangement where a company uses its receivables, or outstanding invoices, as collateral. Typically, accounts receivables financing companies, also known as factoring companies, advance a company 70 to 90 percent of the outstanding invoice value. The factoring company then collects the debts. It subtracts a factoring fee from the remainder of the collected amount it makes to the original company.
The amount a company receives is largely based on the age of the receivables. Under this agreement, the factoring company pays the original company an amount that's equivalent to a reduced value of unpaid invoices or receivables.
Receivables come about when a company sells something but isn't paid immediately — otherwise known as a "bill me later" transaction. The company sends the customer an invoice for payment. They may offer a discount for quick payment.
Companies usually book sales revenue when they make a sale, even before they receive payment. Until payment comes in, sales revenue appears as accounts receivable on the company ledger. When customers pay their invoices, the amount moves from accounts receivable to cash. Before payment comes in, the company has to wait and hope the customer doesn't default.
Instead of waiting to collect outstanding money, a company may choose to sell its receivables to another entity, often at a discount. The company then gets cash up front and no longer has to deal with the uncertainty of waiting or the hassle of collecting.
A company can have a major asset in receivables. The more quickly they're converted to cash, the faster the company can use the money for other things.
Some companies specialize in collecting outstanding monies. If they purchase receivables at 80 cents on the dollar and collect the full amount of the receivables, they make a tidy profit.
Important Factors to Consider
Both sides should consider the pros and cons to these agreements. When figuring out whether to include receivables in an asset purchase agreement and the best ways to structure the agreement, consider the following factors:
- Payment history: What's the seller's history in collecting receivables? How long does it typically take the seller to collect? If the seller takes a long time to collect, or if it writes off a large number of collections, the buyer will be more inclined to demand a bigger discount.
- Collection percentage: How do you set a discount for outstanding receivables? Most agreements allocate varying percentages for receivables based on their age. For instance, receivables that are less than 30 days old may pay out at 90 percent, and those from 30 to 60 days old may pay out at 75 percent.
- Tax implications: Are there potential tax savings if an asset purchase agreement excludes receivables? If so, a seller may have an incentive to exclude them.
- Trust between the parties: Do the buyer and seller have open and honest communication? Do they practice full disclosure in negotiations? If so, there's a lower risk of litigation in the future.
Whether you're the buyer or seller in this scenario, you may want to consult with a skilled and knowledgeable advisor. He or she can guide you through the best ways of structuring the transaction.
If you need help with an accounts receivable purchase agreement, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.