Further Boost To Non-bank SME Finance

Last week, The Receivables Exchange secured $17 million in funding from Bain Capital Ventures.

I've been watching these guys since I learned of their launch in a response to my post about Zopa's trade finance efforts in November 2008. The coincidence was striking then, but even more so when they announced their integration with Ariba Network, the spend management services provider, in December '09.

Here's the video on how the Receivables Exchange works.

The key feature about this form of trade finance is that credit risk can be tied firmly to the buyer, rather than the supplier listing the invoice for 'sale'. There are various ways to understand and mitigate that risk, depending on the size of the buyer and whether it's listed/rated. I'll spare you the detail. Interestingly, the UK Treasury has just launched a consultation on how the government might support non-bank business finance, focusing on corporate credit assessment and transparency.

Of course, the primary challenge is one of marketing this model to enough time-starved small business owners to build 'critical mass' (an expresson I have come to fear and loathe) - hence the $17 million.

Definitely a space to watch.

E-invoicing Integrated With SME Finance Platform

Alternative trade finance for small businesses is beginning to snowball - at least in the US. Early this month, the Receivables Exchange announced its integration with the Ariba Network, a leading provider of spend management services.

The press release says the integration will enable SMEs "to seamlessly transfer their invoices from the Ariba Network to the Exchange’s proprietary trading platform for auction. Leveraging a cash optimizer tool embedded in the latest release of the Ariba Network, suppliers can calculate their cash needs as compared to their eligible outstanding invoices and select the invoices they want to sell to help them optimize their working capital management and improve their cash flow."

This is virtually the same model Zopa and various collaborators took to potential UK clients and partners in 2008. Marketing was the only (major!) hurdle, and we were in talks with someone very big and friendly to support it. But, as is often the way with these types of services, there were simply too many interim integration steps competing against higher core priorities for the service to go into development.

Full credit to the Receivables Exchange for getting this launched - although I still think they need a bigger brand name that is already well-known to all SME's if they are going to get real traction against the established sources of trade finance. I wish them luck.

Maybe it's a signal that Zopa and its partners should dust off their plans...

Mezzanine CoCo Means Even Fatter Banking

Two recent funding initiatives not only fail to introduce openness and transparency in the credit markets, but also add complexity, shroud risk and perpetuate the enormous fees and bonuses inherent in the 'fat banking' model that many are complaining about.

Of course, I'm referring to the new form of 'contingent convertibles' or "CoCos" issued by Lloyds Banking Group and the 'mezzanine' product to be offered by the "Growth Capital Fund".

The £7bn worth of new "CoCos" issued by Lloyds Banking Group pay interest, but convert into equity if the bank's core tier one capital ratio falls below 5%. The tier one capital ratio is itself under a cloud, given its lack of predictive value in 2007 and recent analysis by Standard & Poors that "every single bank in Japan, the US, Germany, Spain, and Italy included in S&P's list of 45 global lenders fails the 8pc safety level under the agency's risk-adjusted capital (RAC) ratio." Furthermore, the ABI says it doesn't like these CoCos being included in bond indexes, because this would "effectively require some bond investors to buy these instruments and subsequently to become forced sellers if and when they convert into equity." It's worth noting that the UK government has had to invest £5.7bn (net of underwriting fees) just to avoid dilution of its 43% shareholding amidst the wopping £13.5bn in new shares. That underwriting fee must be enormous, no doubt made more so by the complexity of the new instrument.

CoCos are a type of convertible bond and are not really new. They started life as bonds that paid interest, but converted into equity if the issuer's share price hit a certain number. Apparently they were first issued by Tyco in 2000. They were popular because CoCos were not included in the diluted earnings per share calculation. However, their favourable treatment was removed and they more or less died out. Some also expressed concern about adequate disclosure of the risk that the contingency would occur, and the future impact of the conversion into equity... seems nothing has changed.

Meanwhile, Messrs Brown and Mandelson have also welcomed the recommendation for new "Growth Capital Fund" to allow medium sized businesses to publicly offer "mezzanine" debt - lending that is often unsecured, and ranks behind bank debt but ahead of equity on insolvency. Apparently, this product "would help address demand side aversion to pure equity, and provide a return above regular bank lending to reward investors". You can guess the reason for the premium to regular bank lending, and why it ranks behind banks. The Growth Capital Fund is designed to plug a "permanent gap" existed for up to "5,000 businesses" looking to raise between £2m and £10m in growth capital." It is noted that "neither banks nor equity investors were likely to fill this gap in the near future." They know that where you rank in an insolvency without security is largely academic, and there remains the very real issue as to how to effectively monitor the ongoing creditworthiness of a mid-tier company. Perhaps the proposed 'single fund manager' might find a solution. But I'll bet it will just sit there gathering money and sending statements to forlorn investors confirming the steady deduction of its fee as a percentage of gross funds under management. Already, Lloyds bankers say they are interested, no doubt hoping to recover some of their recent underwriting fees.

So it's clear that neither of these relatively complex instruments do anything to promote openness and transparency in the financial markets, but instead continue to funnel investment opportunities to intermediaries who can rely on their privileged regulatory position to charge enormous fees.

There are alternatives. At Zopa, for example, we helped figure out an invoice discounting process that is an easily understood, low margin alternative for SME trade finance, open to all - as is the Receivables Exchange. The challenge is marketing such low cost alternatives to busy SMEs amidst all the noise of the usual banking and investment marketing. Low margin financial services providers can't afford fancy advertising campaigns or to arrange open endorsement by Messrs Brown or Mandelson. Yet, to put an end to 'fat banking' and concentrated, poorly understood risk, we need to promote such open investment marketplaces, using instruments that are more easily understood and widely accessible.

Surely that's a challenge the government could help address, rather than lining bankers' pockets.

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.

The Open Internet Exchange

According to the FT:

"The new marketplace, called the Open Internet Exchange uses anonymous information about internet users’ browsing activity to serve up more relevant adverts.The system tracks recent sites visited by the user and any keywords they have entered to search engines to identify their interests, but replaces their identifying details with a random number that cannot be traced back.“We cannot know who you are or where you’ve been,” said Kent Ertugrul, chief executive.

The supplier of the technology, Phorm, says that consumers are given an opportunity to opt-out of having their browsing activity (anonymously) tracked.

The service is being promoted by participating ISPs - currently BT and Carphone Warehouse at Webwise.com: as their "response to consumers’ growing concerns and frustrations with the Internet. Webwise can help protect you from fraudulent “phishing” websites that may put your financial and personal data at risk. It also helps reduce the number of irrelevant, untargeted ads you see."

That site it is offering people the opportunity to opt-in as well as opt-out.

Question is will it be defaulted to "opt-in" when users sign up or next fire-up their internet connection?

And what will this mean in terms of advertising revenue?

"...analysts at Investec estimated that BT and Carphone Warehouse could see revenue benefits of £85m and £65m respectively.

The high margin nature of online advertising revenues meant this could benefit their 2010 earnings by about 1.3 per cent and 10 per cent respectively, Investec said."