With banks cautious about who they lend to and still reluctant to lend at affordable rates, businesses are increasingly looking elsewhere for commercial finance.
A growing source of funding for businesses is invoice financing - the process whereby cash is advanced to firms against the sales invoices their customers have yet to pay. Increasingly, that cash comes from individual investors investing via online platforms.
The term ‘invoice financing’ covers invoice factoring, discounting and trading.
Invoice factoring allows businesses to get a cash advance on their unpaid invoices. The general process goes like this:
- The firm sells its unpaid invoices to a third-party financier
- The financier does not pay the full face value of the invoices; instead it pays the firm a percentage, typically 85%
- As the financier now owns the unpaid invoices, it collects the money due from the end customers
- When the end customers pay the invoices, all the money goes to the financier
- From that money, the financier keeps the 85% they’ve already advanced to the firm
- They then deduct their fees plus interest from the other 15% before paying the remainder to the firm
A disadvantage of this approach for firms is that their customers will know they have sold their invoices to a third party.
In the case of invoice discounting, the financier lends the firm money against a percentage of the value of its unpaid invoices. The firm then collects the money due from its customers in the normal way and pays this to the financier. This reduces the amount owed so the firm can borrow more on invoices from new sales. A fee is charged by the financier for this service.
As the invoices are not sold to the financier, the firm’s customers will not be aware that they are being used to raise finance for the firm.
This is the newest type of invoice financing and involves firms placing their invoices into an online auction individually or in bundles. Investors then bid to buy the invoices and the funds are advanced to the firm.
Once the firm’s customer has paid the invoice, the firm refunds the investor the money they were advanced against the invoice, as well as paying the investor a fee.
A key advantage of invoice trading for firms is that the auction process means investors are bidding against each other to advance funds against the invoices. This tends to ensure that the firm gets a competitive rate.
Invoice trading grew by 179% in 2014 according to NESTA and the average invoice auction duration is just eight hours. Two of the best-known invoice trading platforms in the UK are MarketInvoice and Sancus Finance.
The growth of activities such as invoice trading is due in large part to the internet which has facilitated the process of matching investors with firms seeking to raise funds against their outstanding invoices. It has also made the transfer of money between investors and firms easier.
For investors, invoice trading is a way to buy into short-term corporate debt – bidding on invoices and deciding on the return you're comfortable with. It also gives you another way to diversify risk across your investment portfolio. Investors in invoice trading tend to be institutions, family offices and high-net-worth individuals.
One alternative to invoice trading is peer-to-peer lending, wherein individual investors can lend money to businesses via an online platform, such as ThinCats or Funding Circle. Platforms such as these allow businesses to access term loans without going via a bank. For investors it represents another way of diversifying their investments and gaining a competitive return.
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