Today, as part of our FinTech video series, we are having a deep dive into a young company PeerPay and their invoice trading platform FloFunder.
The Challenge of Working Capital Financing
SMEs are crucial for the UK economy: they represent 99.9% of private sector businesses, 60% of private sector employment and 85% of new job creation. In order to achieve full business growth potential it is important for companies to have adequate access to financing. Many SMEs don’t have enough credit history to borrow from banks, and if they do, banks are reluctant to lend at affordable rates. Overall, bank financing has dramatically decreased since the crisis of 2008.
Only recently bank lending to SMEs has started growing again, but the volume of available traditional financing is still far off pre-crisis levels. Increasingly SMEs are turning to online alternative business finance sources such as P2P lending, debt -based securities and invoice trading. According to Nesta and the Cambridge Centre for Alternative Finance, over £2.2 billion of financing was raised through the above sources in 2015 providing capital to circa 20,000 SMEs.
SMEs are frequently faced with the problem of late invoice payments, which cripple their businesses and can even force closure. Often these are large corporations who consistently delay payments to smaller firms as part of their financial management, imposing terms to withhold payments of up to 90 and sometimes even 120 days. According to a recent report by Amicus Commercial Finance, more than half of UK SME submitted invoices are overdue and 16% of SME invoices are still outstanding after 90 days.
So businesses are increasingly looking elsewhere for alternative finance: crowd-funding, peer-to-peer lending and invoice financing.
Traditional Invoice Factoring and Invoice Discounting
Both invoice factoring and discounting allow companies to fund their growth and cash positions without taking on additional debt and incurring fixed interest rates, via cashing in typically 80-85% of an invoice value within 48 hours of the invoice submission, rather than waiting for over 30 days or more. A funder could be a bank, an invoice factoring company or an alternative financier.
Invoice discounting is usually used by larger companies where businesses seeking finance control their sales ledgers and collect payments themselves. In the case ofinvoice factoring, the credit control function is outsourced to the financier and the customers could be asked to pay the factoring company directly, therefore leaving the clients with no control over their ledger.
Invoice factoring tends to be cheaper than invoice discounting. It could also be useful for one-off invoices, albeit more expensively than in the case of full factoring facilities.
Both traditional factoring and invoice discounting companies prefer to lock in long term relationships with individual businesses, often demanding whole ledger discounting, debentures and guarantees, lock-in periods, monthly service and arrangement fees and unilateral ability to change facility, concentration limits and exclusions.
Invoice Trading Auction Platforms
Online invoice trading reached £325 million in 2015 and is expected to show significant growth going forward (numbers for 2016 are expected to be published in May 2017).
In the last few years, a new type of hybrid invoice trading platforms has appeared, combining invoice finance and peer-to peer lending. The most prominent players in the UK are MarketInvoice and Platform Black.
MarketInvoice was founded in 2010 and is the UK’s largest invoice trading platform. It has funded £1.2 billion of invoices advancing £930 million with average duration of 40 days. MarketInvoice offers more flexibility, speed and convenience than traditional invoice financing: businesses apply online to become a member and once approved can sell their invoices (from £1,000 to £1 million) to a pool of investors. The platform verifies invoices electronically and prices them according to one of 8 risk categories, using various data sources, including company data, online profiling, credit references, etc. Invoices are then sold to a group of investors.
Investors set their investment criteria and can either invest using an autobid function into fractions of invoices to maintain diversification, or select invoices manually. Funding can reach up to 90% of an invoice face value within 24-48 hours. After the debtor pays their invoice the platform pays the company the remaining balance net of fees.
MarketInvoice works with a broad range of industries, supplying large reputable/ blue chip customers often going through high growth phase. Investors on the platform are institutional investors, high net worth individuals, family offices and sophisticated investors. On average 75-85% of investors’ funds are invested at the same time. It is possible to fund invoices in GBP, USD and EUR.
New players – Community Based Matching Platforms
Despite the dominant position of MarketInvoice, new players are emerging, offering differentiated solutions to the same problem.
At the recent FinTech conference in Leeds, Tania Ziegler, the Research Programme Manager at the Cambridge Center for Alternative Finance, stated that the latest trend is community based matching platforms.
PeerPay is one of the new entrants that are challenging existing models and coming up with a fundamentally different approach, based on the idea that any accounting practice, financial advisor or even a trading association or a law firm could match their cash-rich clients with cash-poor clients.
We had the opportunity to interview David Ireson-Hughes, the Group Managing Director, about their new platform, FloFunder.
In its current state, FloFunder is a matching engine within the closed environment of an accounting practice. It matches invoice sellers and funders based on high/medium/low risk profiles that are calculated by an AI-driven algorithm. The key difference in risk assessment is that the platform obtains a real-time feed from the accounting system, currently Xero, providing comprehensive information about the invoice seller and in some cases, the end debtor.
Another differentiator is that FloFunder is not an auction. The pricing is flat: funders’ monthly return on investment is 0.5% for A low risk fund, 1% for medium, and 1.5% for high risk. Accountants have an option of charging 0.25% per month (and it is free for them to join the platform and they have an option of using it under their own brand) and FloFunder charges 1%. So the overall cost to the seller will be between 1.5% to 2.75%, undercutting the MarketInvoice fee of 3.5%.
With a minimum funding requirement of £2,500, FloFunder also gives the opportunity for smaller funders to invest their money, while most other platforms accept only institutional or qualified investors with a minimum funding requirement starting AT £50,000.
Additionally, FloFunder allows to settle up to 100% of the net invoice. It also lets the invoice sellers keep confidentiality about their invoice trading activity. While sellers stay responsible for their credit management process, PeerPay might get involved in assisting them in chasing delinquent invoices. Only in the event of default is anonymity removed and all parties become aware of the end debtor.
According to David, the current annual default ratio on the existing invoice trading platforms is low – only 0.7%, and he believes that it would be even lower on FloFunder, due to the due diligence of the seller and end debtor that is performed at the outset.
Finally, FloFunder allow for a lot of flexibility to invoice sellers, as they are not required to commit all their debtors’ ledger, but can use the platform for selected invoices when it is convenient for them, without on-going maintenance costs.
FloFunder was initially created as a tool for modern accountants who go beyond the role of a book-keeper, acting as trusted advisors for all the financial needs of their clients: “We wanted to champion the accountants, make them heroes, and give them something as a unique selling point”, says Ireson-Hughes.
As the platform develops, the founders are increasingly realising the potential of matching capabilities between different accounting practices and also expanding the platform to different types of clients. The longer term plans include integrations with various accounting software platforms, as well as international expansion.
To learn more about FloFunder’s operating model, its limitations and potential, please watch the full interview with David Ireson-Hughes, the Group Managing Director of PeerPay or visit their website http://flofunder.com.