FINANCE UNDER THE HAMMER
FINANCIAL SUPPLY CHAIN
BY REBECCA BRACE
PUBLISHED Q4 2011
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Finance under the hammer
When credit is scarce or unaffordable, supply chain finance (SCF) is often presented as a more affordable and attractive form of financing. Typically, SCF entails extending receivables financing to strategic suppliers of large buyers based on that buyer’s credit rating. This is
particularly attractive to banks, which are more comfortable with purchasing receivables and paying the supplier early if the buyer is already a customer of the bank and has approved the payables. At a time when optimising working capital and mitigating risk are top priorities, this form of financing is even more attractive, and according to research published by working capital solutions provider Demica in February 2011, some major European banks have seen SCF volumes double in the past two years. But before the success of supply chain finance can be celebrated, it is worth asking which companies are actually benefiting from these solutions? While banks face growing pressure from governments to lend to small-and-medium-sized enterprises (SMEs), through initiatives such as Project Merlin in the UK, in reality these companies rarely benefit from supply chain finance programmes.
Most SCF programmes are initiated by large creditworthy buyers and the biggest stumbling block for SMEs is that their customers may simply not offer them access to this facility, which is often reserved for larger suppliers. “On the supply chain finance programmes we’re involved in, very little is ending up with SMEs,” comments Phillip Kerle, CEO of Demica. “Buyers are looking for the biggest bang for their buck and when they look at their group of suppliers they may not offer supply chain finance to all of them – it’s usually the biggest suppliers, because that brings the biggest benefit.” And adds Enrico Camerinelli, senior analyst, Aite Group: “Banks are not so much in favour of financing small suppliers – that’s why they’re going towards buyer-led programmes. A major issue for small entities is this perceived risk. Another is low volumes.”
Addressing the shortfall
Even if SMEs are invited to join a supply chain finance programme, they may be reluctant to do so, according to Kerle. “Sometimes they don’t want to get closer to the buyer than they already are, if they are effectively using the buyer’s balance sheet, that may concern them.” Looking at funding more broadly, another obstacle may be that SMEs are not always aware of the options open to them. Desbina Michael, finance officer for London-based independent production company, Connected Pictures, feels that banks could do more to provide information on the financing options available. “The government is trying to incentivise the banks to increase lending to small-and-medium-sized enterprises but that information isn’t being disseminated; it’s not reaching us. As a client of one of the major top four banks in the UK, I have never been contacted by my bank manager to say, ‘We have an incentive from the government to help SMEs just like yours, so if you need to increase your cash flow we can provide this for you.’ That information has never reached me.”
Some banks are looking to address this shortfall more proactively than others. Adnan Ghani, head of global trade finance, RBS, comments: “RBS has been supporting UK Trade & Industry in terms of helping SMEs sell their goods into international markets. In this capacity, we were running clinics across the UK, to which we invited thousands of SMEs and talked them through some of the benefits and challenges of exporting to markets outside the UK. Surprisingly, a lot of the enterprises present did not know about their options in terms of reducing risk and generating funding for their exports.”
An eBay for receivables
While supply chain finance may not always be on offer, SMEs may be able to access other forms of receivables financing, such as factoring. However, these techniques are not always suitable for the SME’s specific requirements. Anil Stocker, co-founder and director of MarketInvoice, outlines some of the pitfalls. “Invoice finance is a useful tool for growing businesses but the traditional facilities are unpopular with the SME community because of the way they are structured. SMEs are typically only offered whole turnover facilities.”
Anil says a bank or factoring company will typically say, ‘You need to put all your invoices through us.’ “There’s a contractual lock in; the fee structure is very opaque and the providers take a fee percentage of the revenues but there are all sorts of exclusions – so they might not fund export invoices or certain debtors. Finally, for small businesses these facilities are typically disclosed to the end customer, which is not very popular because it makes the company look weak.” This dilemma was recently encountered by Connected Pictures. After evaluating the options, Michael concluded that traditional invoice financing arrangements simply didn’t fit with the company’s needs. “We typically wait for 90 to 120 days for payment from our large clients,” explains Michael. “They are such large corporations that as a small company we can’t really go in and influence them to try and make them pay earlier. We approached our bank regarding invoice discounting but they wanted a guaranteed amount of turnover each year, in addition to monthly and annual fees. We couldn’t guarantee we were going to put that much revenue through invoice discounting because of the nature of our business.
A more recent alternative to traditional financing models is webbased platforms such as Stocker’s company, MarketInvoice, which is an eBay-style financing platform launched in January 2011. The platform is aimed at SMEs and is so far used by 50 companies. Using the platform, SMEs can post invoices on the platform as and when needed. MarketInvoice seeks approval from the end customer in the SME’s name to confirm that the invoice is received and approved. Financiers can then either bid on a receivable or finance it at the SME’s preferred terms – the equivalent of eBay’s ‘buy it now’ feature. There is currently no joining fee and no other regular fees, and no minimum usage requirements although the value of invoices must fall between GBP 5,000 and GBP 250,000 and the average value is approximately GBP 35,000. The cost of finance achieved by SMEs tends to be around 1% to 1.5% per month but SMEs can expect to see their terms improve the more they use the platform.
An alternative approach
Johnny Walker, founder of city recruitment firm Magnus Walker & Partners, began using MarketInvoice earlier this year and has so far auctioned approximately GBP 65,000 of receivables. His second auction closed within two hours and the funds were in the bank account the same afternoon. The funding allows Walker to pay interim executives for their services within seven days, even though the blue chip clients they are working for may take 35 days to settle the invoice. “It enables us to compete with companies 50 times bigger than us and say, ‘We can do what they do,’” comments Walker. “Its reputation enhancing for us and it’s reassuring to our clients that our interims are being paid promptly.”
While the receivables marketplace model is certainly a recent innovation, MarketInvoice is not the first company to use this model. The Receivables Exchange offers a similar service in the US market. An interesting aspect of these newer models is that they not only provide SMEs with additional sources of finance but also bring financiers a new investment vehicle. As Stocker explains: “These buyers [of SMEs’ receivables] are hedge funds, asset managers, high-net worth individuals. They are people who have never been able to channel money to the SME sector because there’s been no centralised way of doing it. Unlike the banks, what they do have is a lot of capital, which they are not getting a lot of return on at the moment.” It is early days yet, but this model does present an interesting alternative to traditional receivables financing techniques and in the current climate may well be worthy of consideration.