Money comes at a price. The more willing your lender is to take risks, the higher the return expected. That translates to your borrowing costs and what you have to bring to the table. Practically speaking, if your business does not have the trading history or serious collateral needed by a lender, invoices and orders may be your best bet.
Invoices are the key to unlocking lending. Not necessarily financing the invoice(s), but using them to assess/demonstrate ability to pay and include them in any security/collateral package.
Leading up to 2008, bank lending crowded out invoice finance. A relationship banker in a mid-sized bank in the mid-Atlantic area explained that deal size and information requirements made term lending or overdrafts more competitive, noting “ it’s been easier for us to give the business a secured loan than to do all the work needed in an invoice financing”. Today, with wholesale funding markets (what allowed banks to lend cheaply) contracting, invoice finance’s 300 year+ simplicity can be a good route to funding businesses.
Why? Since banks have less to lend, their risk appetite has gone down even further. Owners guarantees, fixed assets and other collateral become central to their credit decisions.
Invoice finance, while often more expensive than traditional loans and credit lines, makes sense if:
· a business is owed money by other businesses with a better credit standing than its own;
· it sells to other businesses on credit terms longer than 30 days; or
· the business wants to take advantage of credit control services offered by an invoice financier.
If the business is effectively providing vendor finance (i.e. supplying on 60-90 days credit) to its customers, its invoice finance charges are really a cost of sales. Due to its short term nature, I’ve seen most businesses use invoice finance for working capital and short term needs. If needing to finance growth and expansion, a solid business case will yield better priced financing geared towards the expansion project. I’ve very rarely seen businesses refinance expensive debt using invoice finance.
Invoice lenders tend to be less interested in the business’ intended use of funds. Traditional invoice lenders have been, in my experience, primarily focused on whether they will get paid. They look at the payment history of the buyer and its credit standing in addition to the financial standing of the borrower. If financing on a non-recourse basis (i.e. if the debtor/customer defaults, the lender has no recourse to the borrower), the standing of the borrower concerns them less.
I see more cases where the borrower remains ‘on the hook’ (i.e. if the customer does not pay an invoice, the borrower has to repay any advances taken from the lender) and thus, the business borrower’s credit circumstances are carefully assessed. Unless a ‘true sale’ has taken place, lenders, purchasers, even auctions can claim back advances against an invoice if it remains unpaid.
There seems to be a lot of confusion among businesses and their advisors about whether (and when) invoice finance is suitable. Bottom line is that if done right, invoice finance can be an effective part of your overall business’ financing.
In the next part of this article, I’ll talk about some suitable circumstances and also touch upon supply chain finance.