Catalyst's guide to the alternative finance market - part 3
Continuing from the last post I explain key characteristics of another two alternative finance products: Invoice Trading Platforms and Selective Invoice Finance.
Invoice Trading Platforms
Invoice trading is a distant cousin of traditional invoice finance in that it provides a way of generating cash from a debt which is not yet due to be paid.
The amount of the debt is defined by an invoice and when offering the invoice to the platform, as the borrower, you specify how cash much you hope to be able take in advance of your customer paying. This will be a percentage of the total invoice value.
The invoice trading platform will pre-vet the invoice, looking mainly to ensure that the debtor is credit-worthy. If satisfied with the quality of the debt, full details of the invoice will be posted on the platform and a bidding process begins.
Potential lenders who are attracted to the invoice will offer an amount and a rate they are happy with. In this way, a reverse auction begins whereby, if there is an over-subscription for that particular invoice, those bids offering the lowest interest charge will succeed. Alternatively there may not be sufficient interest and the trade will fail.
By selling the invoice to a third party, money due at a future date becomes available for you to use now. When the invoice becomes due the debtor pays directly to the platform rather than to you but you remain responsible for making sure the invoice is paid.
When the platform receives payment it deducts its own charges from this money and then repays the amounts lent together with interest to the individual lenders.
Any residual money left after these deductions have been made is repaid to you. If there is insufficient money after repayment, you will be asked to make up the shortfall.
Although the expectation is that lenders will be repaid from the proceeds of the invoice, most invoice trading platforms have now started to take additional security in the form of a charge on the business (debenture) and a personal guarantee from the directors and/or shareholders of the borrower.
Once again, invoice trading is exclusively web based.
Selective Invoice Finance
Selective invoice finance (sometimes referred to as spot discounting or single invoice factoring) is also a close relative of traditional invoice finance but with important differences. Catalyst Finance is the leading provider in this space.
Unlike the traditional model, you remain in control of your debtors and decide when and how much cash you want to raise from whichever debtors or individual invoices you choose. You are not tied into any contract so can walk away from the relationship whenever you want to.
Unlike all the other forms of alternative finance, selective invoice finance is not web based so operates in a more personal way – relationships are key. As well as Catalyst a small number of specialist providers offer selective invoice finance.
As with all forms of alternative finance, the value of selective invoice finance to a business is that it unlocks cash tied up in that business’s debtor book for goods delivered (or work completed) which will be paid at a future date. Generally there are no restrictions on what the money can be used for but typically it will be to fuel growth or to deal with occasional or seasonal cash shortfalls.
Unlike web based alternatives, selective invoice providers agree an ongoing facility for the business which is available for use when needed – somewhat akin to an overdraft facility. Getting the facility in place is quick (typically less than a week) and thereafter, the process of drawing money from the facility is virtually instant provided the validity of the invoices selected for financing can be verified.
In the case of Catalyst, the mechanism for raising money is simple. Invoices are sent (typically emailed) to Catalyst for verification. Once verified, an agreed percentage of the invoice value becomes available to draw – typically 70% to 85%. This can be drawn whenever needed either in one go or in multiple tranches with the opportunity to repay early if additional funds become available in the business from elsewhere. This gives you direct control over the cost.
Selective invoice finance is a “people” business which is more about developing relationships and mutual trust than it is about ticking boxes. In this respect at least, selective invoice finance stands out as being very different from the other types of alternative finance which are available. The focus is on finding solutions and every potential transaction is looked at on its own merits with “thinking outside the box” being the norm. There are never any “computer says no” moments.
As with virtually all other types of finance, additional security is required to support the facility. Typically this will include a charge over business assets (debenture) and a personal guarantee from the directors or owners.
So what are the pros and cons of these new financing options?
In part four of this series we will look more closely at what is good and bad in each of the options referred to here. We’ll be looking at costs and will try to give some guidance as to the right questions to ask to avoid pitfalls and to make sure that whatever decision you make you do it with your eyes wide open.
Jeremy Lawrence is the Founder Director of Catalyst Finance