Reserve

The reserve is the share of the value of the financed assets that the factor or asset-based lender keeps out of the borrower’s reach to cover specific risks. The European definition of factoring describes it as the share of the receivable that the factoring company retains to cover specific risks such as dilution. In factoring, it takes the form of a guarantee fund. The factor estimates the minimum outstanding amount under the contract, equal to one sixth of the annual minimum assignment volume, and asks for a deposit of 10% to 15%, or even 20%, of this amount. The company negotiates the interest paid on this deposit with the factor. In a borrowing base facility, the lender deducts the reserves after applying the advance rate to the eligible receivables and inventory. The usual categories are the dilution reserve, accrued social security and tax liabilities, unpaid rent in countries where the landlord has a lien over the tenant’s assets, and disputed obligations. High or volatile dilution leads the lender to lower the advance rate or to create a dilution reserve. The reserve reduces the company’s drawing availability. Factors charge specific fees for releasing a guarantee fund or reserves outside the parameters of the contract.

A mid-cap assigns €200m of invoices a year to its factor, with an annual minimum assignment volume of €180m. The factor estimates the minimum outstanding amount at €30m, or one sixth of this minimum, and asks for a guarantee fund of 10%, or €3m. On €30m of financed receivables, the company receives €27m as long as the fund remains blocked.

• Negotiate the interest paid on the guarantee fund and the terms of its return at the end of the contract.
• Have the contract list the categories of reserves the lender may impose and their criteria.
• Ask for prior notice before any new reserve or any increase in an existing reserve.
• Check that the dilution reserve is recalculated each period on the observed rate.