Is unsecured SME lending too risky?
If you think p2p unsecured lending to SME borrowers is too risky, there are a few less risky alternatives: asset-based p2p lending by New Union and Silver Bullion; and invoice crowdfunding by InvoiceInterchange and Capital Match. New Union is difficult to understand because it is a platform-cum-lender and takes an interest spread on each loan, while Silver Bullion requires physical gold or silver as collaterals. In my view, invoice crowdfunding is more accessible to most people. Therefore, the focus of this post will be on invoice crowdfunding.
Invoice crowdfunding is very new in Singapore. As far as I know there are only two platforms: InvoiceInterchange and Capital Match. Please refer to our previous post on an interview with InvoiceInterchange’s founders.
What is invoice financing?
Invoice financing refers to the sale of accounts receivables by a company for immediate cash. It is a form of short-term financing often used to improve a company’s working capital position. Invoice financing is similar to short-term loans, although there are some differences.
In a p2p context, there are 4 parties: the company (or seller of the invoice), the company’s client (or debtor), the p2p platform and the investor. The simplified interactions between the four parties are shown below.
Why is invoice financing less risky?
If managed well, invoice financing can be less risky than unsecured loans because:
- Invoice financing is backed by an invoice.
- The credit risk is primarily on the debtor, rather than the company itself. Debtors are usually large, well-established corporates, with lower credit risks.
- The invoice is typically sold for 70-90% of its value, giving the investor some protection in the event that the debtor does not make a full payment.
- If the debtor fails to make payment, the sellers are typically required to purchase back the invoice (recourse option).
What are the risks?
- Invoices can still default. This happens when the debtor fails to pay and the seller is unable to purchase back the invoice.
- The invoice may be fraudulent.
- The p2p platform may fail.
What is invoice factoring and invoice discounting?
There are two main types of invoice financing: invoice factoring and invoice discounting.
- Invoice factoring is a disclosed facility. The debtor is aware that the invoice is sold to third party, a factor. In a p2p context, the third party will be the p2p platform, acting as an agent for investors. Payment will be made directly into the p2p platform’s account.
- Invoice discounting is a confidential facility. The debtor is unaware of any invoice discounting between the seller and the investor.
We’ve just scratched the surface of invoice financing. For more information on this topic, please refer to InvoiceInterchange’s excellent blog (more links below). In our next post, I’ll walkthrough a recent invoice trade that I participated in.
Invoice Crowdfunding versus p2p lending
Invoice Finance versus Asset-Based Lending (table extracted below)
|Factoring||Invoice Discounting||Asset Based Lending|
|Mid to long term funding needs||Yes||Yes||Yes|
|Requires business to business receivables only||Yes||Yes||Yes|
|Requires legal title to receivables||Yes||Yes||Yes|
|Requires robust ‘in house’ ledger control||No||Yes||Yes|
|How much advance can be expected.||Up to 90% of the value of eligible invoices||Up to 90% of the value of the outstanding balances from eligible debtors.||Up to 90% of the market value of the eligible assets|
|Do you collect money on my behalf?||Yes||No||No|
|Do your customer know of this arrangement?||Yes||No||No|
|Do I have protection from debtor insolvency both domestic and export?||No||No||No|
|Does funding increase working capital?||Yes||Yes||Yes|
|What kind of turnover is required?||Small (less than 200k)||Medium (less than 10 millions)||Large (over 10 millions)|
|What are the differences in pricing?||Generally more expensive than Asset based lending||Generally more expensive than Asset based lending||Generally cheaper than invoice factoring and invoice discounting|
|How quick is the assessment / on-board process?||Fast||Fast||Slowest|