Monday, 17 November 2008

Early Payment of SME Invoices

Today the FT reports that "88 per cent [of traders surveyed] reported bigger companies not paying on time – a factor that 72 per cent said had a serious impact on their business."

Early this year I was involved in discussions about a way for individuals with surplus cash to enable SME's to get their invoices to big corporates paid early - and at rates that are competitive with SME's current financing options, represent a great return on people's spare cash, and allow big corporates - and the public sector - to extend their payment terms. This would be additional to SME's current financing options, rather than interrupting or replacing them.

The parties required to implement the necessary process agreed how it should work in detail. Their remaining challenge was finding the SME-facing brand necessary to market the service effectively. Early discussions with the perfect brand yielded some progress, but ultimately launch depended on another of their initiatives progressing.

One way it could work, in basic terms, is that the supplier offers to assign the invoice to Zopa or a collection agent for the benefit of the Zopa members who chip in to pay it early. Notice would need to be given to the corporate buyer to pay the invoice amount to the Zopa members' account. Someone at Zopa would also need to call the corporate buyer to ensure it was happy with the arrangement and confirm the date the buyer is promising to pay. That promised date could go on the invoice listing. Zopa members could then study the listing and decide what discount rate to offer (credit reference data would be available for those that want it). There would be an auction, so pricing would be very transparent.

There's another model that would work in reverse, with buyers posting invoices it's prepared to pay - with a promised payment date - to suppliers' accounts. The suppliers could then hit a "Pay Me Now" button that takes them to the Zopa site where their invoice could be listed etc. While that model is certainly technologically possible now, I suspect that it would follow once people got the hang of the supplier-driven process.

At any rate, if you're a supplier to big corporates who's frustrated by their extended payment terms, why not contact Zopa and say you're interested in either model I've described?

Maybe the continuing explosion of the late-paying problem, coupled with falling savings rates on people's spare cash, will hasten the implementation of this solution.


Unknown said...

Not sure why random cash rich individuals would want to become invoice factors.

In Yeltsin Russia there were systems of promissory notes and reassignable invoices that stood in for the banking system after it collapsed. Everyone took paper from their customers, and sent it back to their suppliers. IOUs from electricity utilities would circulate as a local currency, and the big local firm's billing departments would effectively function as banks.

Obviously it was a giant grinding bookkeeping headache, but that's what computers are good for right?

Pragmatist said...

Similar reasons they lend to creditworthy individuals at Zopa today: the spread between savings and loan rates that they get to share when you take a bank out of the middle; and it's a new asset class for your personal portfolio.

In this case there's an even healthier spread between savings rates on spare cash and the rates SMEs have to pay for finance against their trade receivables vs rates in the personal loan market. I'm told that it's not unusual for small businesses to be saddled with annualised rates equating to 36%APR (to use personal loan terms).

Your money would also only be tied up for, say, 30 - 90 days rather than about 18 months or so it takes most 3 year personal loans to redeem; and you could diversify across invoices, buyers, and suppliers to reduce risk. There is also publicly available credit reference data on buyers for those who want it.

Unknown said...

I think that's only slightly below the rate that Indonesian fishing villages get from their moneylenders! So much for progress - I never realised it was that high.

I'm not certain how an individual would collect on a trade receivable if the payer was overdue. I suppose a straight 90-day loan would be manageable; the rich person just waits for the administrator to send them whatever's left.

The commercial paper market in the UK is open to fairly small firms (if I'm understanding my IB friend's drunken ramblings correctly). Providing there's credit rating data and filled accounts, I don't see why it couldn't be extended down to SMBs. They'd be a higher risk premium, but nothing like Libor+32%!

It's an interesting question whether you could actually get on-time payment by just shaming big firms. Rationally, if Tesco openly delayed payment to their small suppliers, the markets should see them as weak and push up their risk spreads in the capital markets. Or it could be such a habitual practice that no-one would judge them for it...

Who does credit scoring on businesses? I've only heard of TradeRadar, and they seem to have disappeared.

Pragmatist said...

Thomas, I see you have the bug!

To be clear, these wouldn't be loans, but a straight assignment of each invoice (debt). That's why it wouldn't interrupt existing finance facilities. Early payments could be to a supplier's "locked box" account, just like any other early payment in the ordinary course. A collections agent would chase the debt, as normal, though it may have volume on its side if lots of suppliers had sought early payment.

This would be for trade receivables less than $200m pa. The discussions I mentioned were actually initiated by someone who already finances receivables above that number and was interested to see if Zopa members might take any flow of smaller stuff.

As to the commercial paper market: on a separate matter I was once quoted about £100k to set up an unregulated commercial paper offering. So you'd need 10s of millions of debt to to make it worthwhile, and a market-maker willing to hold/warehouse the debt until there was enough to interest potential bondholders. Not something they like doing with their capital at the best of times, let alone now.

While defaults might have that effect, the "shaming" of any non-paying buyers is not really central to success here. Big buyers should like such a marketplace, as it presents an opportunity to extend payment terms while suggesting a transparent, independent source of finance for people who want to be paid early. They would be nuts in those circumstances not to honour the confirmed commitment to pay the invoices. In fact, in the buyer-driven model, they would already have issued a batch file containing the order to pay the listed accounts on a set date.

Of course, extending your payment terms with notice to suppliers is one thing, but delaying payment on existing invoices already issued on previously agreed terms is quite another. The latter stunt would result in a call from the collections agent, and invoices issued to that buyer probably wouldn't be welcome in the marketplace again.

On credit-scoring, you could see a range from just making available links to providers of credit reports for members to buy if they wanted them, to gradually building a kind of star-rating system based on key criteria transparently derived from such reports, with click-through to the report.

Unknown said...

Oh, look.

Pragmatist said...

Aha, you see? Fantastic. Thanks for pointing this out.

I can't seem to find any statement about why this is not somehow subject to US securities and/or exchange regulation. That appears to be something that our colleagues across the pond worry about later on - e.g. Prosper and LendingClub.

I can see a start-up being able to get enough volume to gain traction in the US market, but best not to underestimate the marketing challenge in the SME marketplace in the UK...

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