Receivables Financing

Receivables financing – an alternative option

Receivables financing also referred to as invoice financing, invoice discounting and supply chain financing involves the sale of a debt (owing to a company by a third party debtor) to a lender in exchange for a lump sum ‘advance’ by the lender to the company. This allows the company to obtain funds in advance of when it would otherwise expect to receive payment of the debt owing to it.

If the company’s debtors are creditworthy entities a receivables financing arrangement can be cheaper than other traditional debt. The lenders are primarily concerned with the creditworthiness of the debtor under the contract and so if the creditworthiness of the debtor is superior to the company, this type of financing may be cheaper for the company than seeking funding based on its own credit profile.

The level of recourse to the company in receivables financing will vary based on the transaction but will usually be one of the following:

1. full recourse to the company so that if the third party debtor fails to pay the amount owed to the company, the lender will look to the company for reimbursement of any funds they have advanced against the invoice; or
2. recourse which is limited to the occurrence of certain events (e.g. fraud or commercial dispute). This means that if the debtor fails to pay the amount due to the company (for example, due to insolvency), the lender wears the cost. In this situation the lender and the company agree that in relation to purchased receivables, the lender’s primary source of repayments is payments made by the third party debtor.

Benefits to the Company

Benefits of receivables financing to the company include:

1. access to liquidity: allows improved access to liquidity by reducing the number of days sales are outstanding;
2. improved balance sheet management: usually characterised as an off-balance sheet transaction rather than debt obligation;
3. reduced financing costs: discount to face value of invoice is calculated on the debtor’s creditworthiness resulting in lower financing costs than would otherwise be incurred for a working capital facility;
4. risk management: in limited recourse transactions, the company is able to protect against debtor’s payment default and insolvency risk; and
5. elimination of early payment discounts: the company no longer needs to encourage the debtor to pay early, so they are able to remove early payment discounts.

Benefits to the Lender

Benefits of receivables financing to the lender include:

1. higher return on equity: compared to debt financing, receivables financing typically has a better return on equity;
2. self-liquidating: the lender’s exposure is self-liquidating, short term exposure with end to end controls in place;
3. lower price elasticity: provides the lender with an annuity income with a more consistent pricing range; and
4. relationship: receivables financing transactions typically assist lenders in becoming a strategic partner to assist companies in managing their supply chain financing arrangements.

Receivables financing is generally regarded as lower risk than debt financing due to the lender’s credit exposure being to a third party debtor which will typically have a better credit position than the company. However, some risks include:

1. fraud: the issue of false invoices to obtain the benefit of immediate financing;
2. comingling: where sale of receivables are undisclosed and debtors pay funds into the company’s operating account on the company’s insolvency funds may be treated as business assets available to all creditors rather than proceeds due to the receivables lender; and
3. dilution: where the debtor pays less than the full value of the debt on the maturity date as a result discounts, rebates, commercial disputes or set off arrangements.

The team at Wright Legal have advised on numerous alternative financing structures and enjoy assisting our clients in navigating the issues safely.

If you are considering a transaction like this, we are happy to help.