Tools of the Trade

Unlocking Cash Through Supplier-led Solutions

Supplier-led financing solutions for releasing cash have grown to become a major element of international supply chains. In a recent webinar, TMI’s Editor Eleanor Hill explored the essentials of trade receivables finance and trade receivables securitisation with Maurice Benisty, Chief Commercial Officer at Demica, and Ingmar Bergmann, owner of IMB Consulting.

For as long as they have existed, supply chain financing solutions have helped buyers and suppliers to unlock working capital efficiencies, while making their supply chains more resilient. But for those unfamiliar with such solutions, they can seem daunting – and the terminology around them can also be confusing, especially since since different banks and providers refer to these products by different names.

As such, before exploring practicalities, it is worth starting with the fundamentals:

• Trade receivables finance is a version of supply chain finance where businesses can gain funding for invoices owed to them before the payment date is reached. This means they can access working capital currently trapped in their supply chain, improving their cashflow. The term can encompass several different types of solutions from factoring to receivables discounting programmes.
• Trade receivables securitisation is a way for large corporates to sell pools of their outstanding invoices into a special purpose vehicle (SPV) which in turn will issue securities or notes to investors. Investors will commit to purchase the notes for up to five years against a formula that considers dilution and loss history. Securitisation is ideal for companies with large numbers of customers and can aggregate receivables from operating companies across different geographies and business units.

Growing demand for solutions

Bergmann notes that all forms of receivables financing appear to be on the rise – for several reasons. Factoring, for example, traditionally a manual process, has become more user-friendly thanks to technology. “So-called subsidy financing from governments responding to the pandemic temporarily removed the need for factoring, but the post-Covid era has seen rapid interest rate hikes worldwide,” he reports. “As funding grows increasingly expensive, factoring is once again an attractive option, while banks have lost interest in the work involved in capital financing.

With inflation resurgent, companies also want alternative funding solutions and lower cost options, such as trade receivables financing”, says Benisty. “The post 2008-2009 era of low-to-zero interest rates lessened motivation to start up a programme. But the focus is very much back on securing working capital benefits while also shoring up supply chains, so it’s something of a perfect storm.” Indeed, TMI’s own LinkedIn polls asking companies about the need for working capital finance saw 79% reporting that it has become a higher priority than in 2022.

Facilities supporting a trade receivables finance programme are committed, so purchasing will continue on an ongoing basis, Benisty explains. “This enables the initial amount of liquidity to be unlocked and the facility sized to accommodate growth in the company’s underlying commercial activity.”

Demica’s facilities usually see the company continuing to manage the relationship with debtors, permitting, as far as possible, no interference with the underlying terms of trade. However, the funder will often want payment made into a pledged account – or discrete account – to avoid commingling with any other receipts the company takes in.

“This can mark the point where complexities begin, for example ensuring that customer contracts allow for the sale of the receivable and avoid saddling the funder with additional risks,” notes Benisty. Demica sits in the middle to manage reporting, often pulling data directly from the corporate to deliver the reports in the required format for the funder.

“We focus on portfolios of €20m-plus. Deals are possible for smaller amounts but tend to be bilateral with relationship banks or funders. Our team looks for a level of complexity in the pool of receivables – such as multiple currencies or multiple legal entities – that it can manage before taking a transaction live.

“We have encountered a wide variety of use cases for companies looking to monetise whole portfolios of receivables ranging from additional capacity to fund growth, to cost reduction relative to other forms of asset backed lending. The largest deal we have placed to date was for €500m and we have worked on innovative structures to enable syndication and other multi funder solutions.”

Despite the considerations around trade receivables purchase programmes, “I keep a positive outlook,” says Bergmann. “Selling off the company’s invoices will produce a substantial amount and any company with a regular sales pattern will see new invoices in the programme balancing older ones being paid off.”

Bergmann continues: “I’d urge companies thinking about using factoring to ensure the loan documentation permits it because often it is prohibited. Potentially a better option is to have a non-recourse agreement, where the invoice is sold off, free of liabilities, so risk transfers to the third party which is often accommodated through language around permitted sale of assets in loan documentation.”

In addition, he cautions that both internal contracts and customer contracts must be up to date to pass due diligence by the factoring company, which will want to ensure that should it go to court for any reason, the contract is valid.

Furthermore, to ensure everyone involved in the deal is on the same page, Benisty recommends the paperwork for a receivables purchase programme covers set questions. These might include:

• Do your senior loan agreements give you permission to sell receivables?
• Do your customer contracts include any clauses that might preclude it?
• What are the payment terms, and do you regularly get paid late? That could create an issue regarding the advance rate.
• Consider the legal issues relating to the jurisdiction of the entity selling the receivables e.g. sale to an entity based in a different jurisdiction. 

“Preparation is key, so is awareness of differences between jurisdictions,” Bergmann advises. “A facility in France or Germany is more likely than a US one to have a different price point and depth of market. Europe’s factoring market has evolved over years to develop familiarity with major transactions, while the US market still focuses on SMEs. Europe also has regional variations, for example, Italian companies divide up their portfolios across multiple different funding providers according to who is best placed to take the credit risk.”

Trade receivables securitisation

As outlined above, the distinguishing features of receivables securitisation are that discounting applies, and rather than selling direct to the funder, the receivable goes into an SPV that creates notes for sale to investors.

According to Benisty, “the funding mechanism for the sale is both different and more complex”. Due diligence therefore must determine which debtors can be included, the underlying contractual terms, and the collection processes deployed. Another key difference relates to the type of company for which securitisation is appropriate. As previously mentioned, it best suits companies with a large dispersed customer base where it is possible to aggregate receivables.

Positives include minimal underwriting required of individual debtors, and, in most cases, no requirement for credit insurance. When the largest debtor represents for example 8%-10% of the portfolio, Benisty believes obtaining securitisation should prove easy but adds that “a more ‘lumpy’ portfolio presents more of a challenge”.

While constructing a trade receivable securitisation usually takes longer than a trade receivables purchasing programme, the former offers both cost advantages and operational benefits. Some of these potential upsides include:

• Stable, long-term source of financing. A securitisation facility based on a global receivables portfolio owned by the SPV typically benefits from a two to five-year financing commitment from investors.
• Single facility for all operating companies. The pooling of receivables (across operational entities, currencies and countries) enables the treasury team to have a global view on the receivables’ performance. Due to the assessment at portfolio level (and not at operating company level), the performance of the receivables is more stable, resulting in an optimised financing level for all companies.
• Competitive funding cost. A trade receivables securitisation programme enables access to deeply liquid capital markets and its set-up costs can typically be amortised over several years.
• Highly scalable. A trade receivables securitisation programme makes it easy to add new operating companies and investors over the life of the programme.

Securitisation involves reviewing the performance of a portfolio of debtors and, over a three-year period, assessing its robustness and whether that performance is likely to continue. The main challenges here are the need to review more data, and the modelling of performance is more complex than a straightforward receivables discounting arrangement.

Demica has a four-phase process, comments Benisty. “These include delivering a free cost benefit analysis to the company based on our analysis of the portfolio and what we can deliver from our funders; preparation of the company’s data and developing the structure so we can generate rapid responses from funders; selection of funders and negotiation of legal contracts; and then finally automating the reporting to take the programme live on our platform.”

Data comes in various formats from different operating companies, while the funding market is fairly opaque and functions differently from loan and other capital market products. For Benisty, Demica’s intimacy with funders is a “valuable resource”, while being able to outsource complex reporting and change requests enables us to develop strong relationships with treasury teams over time.

Securitisation where multiple subsidiaries and multiple jurisdictions are involved, and each subsidiary submits invoices to the fund, requires a well-resourced treasury department or finance company functioning as the sole entity selling to a third party, Benisty suggests. He recommends too that treasury teams have active discussions with accounting colleagues, “to ensure everyone is aware of the appropriate accounting treatment”, and that they also organise workshops with the provider.

“Five years probably marks the limit of commitment for these types of facilities, as you can also get uncommitted facilities, one-year commitments or rolling two-year commitments,” explains Benisty. Demica is currently reviewing a transaction involving numerous operating companies and its scope for a receivables discounting programme, which is focusing on two or three large initial pools, with a view to adding other sellers over time.

It’s worth noting that funders have often proved flexible in agreeing to their change limits. One Demica client completed a €175m receivable securitisation in 2020 that has since grown to €400m, reflecting the capacity to increase or decrease the size and vary the scope.

“The key lies in keeping it simple,” stresses Benisty. He provides a salutary lesson: “Take the example of one failed deal which, to be viable, needed seven operating entities to join the transaction. Technical hitches and local resistance prevented a couple from doing so, and management of the local subsidiaries did not want to be part of a group enterprise, which left an expensive, small facility.”

Do your homework

While supply chain financing solutions driven by both buyers and suppliers are a hot topic again for several reasons, potential users must do their homework because every programme is tailored, requiring upfront investment and co-ordination, stresses Bergmann. “Colleague support is essential at each stage, from contracts and accounting to the technical side. Without that, any programme will struggle to be a success.”

Benisty concurs. “There may be barriers to doing a deal, so jumping the gun and going straight to funding providers before addressing the potential hurdles risks losing momentum. And your ability to optimise terms, whether on advance rate or price, depends on preparing and running a professional process. Funders appreciate the effort because they dislike long cycle times and the break rates on deals – so doing your homework means you can quantify the benefits up front and deliver against a well thought through and structured plan.”