[Editor’s Note: This is a guest post from Simon Hermiz, a Credit Risk Management Professional and former Co-Founder at NoteX, a company that provided an institutional investment platform for direct investing in trade receivables and marketplace loans.]
Launched in 2008, The Receivables Exchange was one of the first online marketplaces for trade receivables. Since then many invoice trading platforms have emerged each pursuing their own market niche.
Here is a sample list of invoice trading platforms targeting SMB’s that are open to institutional investors:
|FastPay (US)||Asset Based Lending||2009|
|P2Binvestor (US)||Asset Based Lending||2012|
|Aztec Exchange (Global)||Export Finance||2012|
|Market Invoice (UK)||Select Invoice Discounting||2011|
|The Interface Financial Group (Global)||Select Invoice Discounting||1972|
|CrossFlow Payments (Global)||Supply Chain Finance||2010|
|Platform Black (UK)||Supply Chain Finance, Select Invoice Discounting||2011|
Under current market conditions, investors can expect gross annual yields between 8-15% and annual loss rates between 1-3% assuming you are in a senior secured position. The average days outstanding (DSO) can be 40-70 days depending on the platform.
The growth of these platforms is driven by demand from small businesses looking for better financing options and investors seeking short-term high yielding assets. In this blog post, I will discuss invoice factoring, a common invoice finance product and its growth opportunities in online marketplaces. The goal of this post is to inform readers and investors about this fast growing product segment.
Invoice finance comes in many variations; examples include factoring, reverse-factoring (or supply chain finance), invoice discounting, asset-based lending, and securitization. Invoice factoring involves the purchase of accounts receivable by unrelated third parties.
The factoring industry is very fragmented with small and medium sized factors making up a significant portion of the market along side heavy weights like Wells Fargo, CIT, and Bibby. These factoring companies tend to concentrate on a few industries in which they have expertise. The reason being that each industry requires specific knowledge in structuring, due diligence, legal documentation, and credit underwriting. For example, factoring medical receivables such as claims issued by Medicare requires deep understanding of how claims are billed, processed, adjudicated, and paid.
To help new investors better acquaint themselves with factoring transactions, I have put together a preliminary list of topics and questions that can be used as part of the screening process when evaluating investment opportunities from invoice platforms.
Note: It is important to understand the legal framework related to the “sale of accounts” and “perfection of security interests” in the jurisdictions where accounts are being factored. The following list assumes US law.
- Identify the industries the platform will be serving and their client acquisition channels. Certain industries such as Construction carry a higher level of risk and complexity, so it is important to make sure the platform has the expertise and track record to structure and service these types of transactions.
- Understand how your investment is structured.
- Are you funding a credit facility, purchasing participations, purchasing entire invoices, or purchasing trust certificates issued by a structured vehicle?
- If multiple investors are involved in a transaction, how are capital losses assigned amongst investors?
- Does the platform have any skin in the game? Does the platform subordinate or forgo their transaction fee when investors experience a capital loss?
- If the platform goes out of business, how are you interests protected? Do you have the right to contact and collect from the customer or client directly?
- Understand how the platform is structuring transactions.
- What level of recourse does the platform have against the client? Most domestic factoring transactions are full-recourse with the exception of transactions executed in limited recourse states.
- What are the platform’s advance rates on purchased invoices and client collateral bases?
- Does the platform assign purchased accounts using a legal or equitable assignment? A legal assignment being the preferred method because it allows you to perfect your security interest in purchased accounts.
- Does the platform file a UCC-1 financing statement on the client’s accounts and does the platform advance on accounts from a subordinated position? If the platform is advancing from a subordinated position you are assuming more risk and should be compensated accordingly.
- Traditional factoring implies that transactions are disclosed to the client’s customers and payments directed to the factor. It is important to check whether the platform is adhering to these practices.
The Challenge and Opportunity for Online Marketplaces
There is no doubting the increased interest from platforms looking to offer invoice finance products. The main challenge for these platforms will be client acquisition. Established markets like the US and UK have many competitors both banks and non-banks offering speed and convenience. This makes it difficult for platforms to differentiate themselves, which will result in higher client acquisition costs. In fact many traditional factors in today’s market are finding themselves having to lower fees to attract clients.
However, the situation could not be more different in emerging markets in Latin America, Africa, and Asia, which present significant opportunities. European banks have been exiting these markets since the financial crisis leaving many SMB’s with very few financing alternatives. Platforms targeting emerging markets will have fewer competitors and plenty room for growth granted they can manage all the risks effectively.
While the invoice finance market presents many opportunities for investors, it is important to arm yourself with the right information and knowledge. This blog post can serve as a good starting point for prospective investors interested in exploring this space further.