A guest blog and opinion piece from one of our sales team, Kamil Mieczakowski discusses the hidden perils of some types of invoice finance.
Invoice factoring and discounting products were designed to free up working capital against a company’s outstanding book debts. They tend to be advertised as growth tools but, as it is with most financial products, the devil is often in the detail.
Many businesses initially attracted to traditional factoring or invoice discounting down the line realise that what they signed up for doesn’t fit their objectives. Furthermore, once the contract is signed the facility generates additional costs, even if not used. At that point it’s usually too late to simply opt out.
“Mr Victim, I’m glad to say that I’ve got the go-ahead to lend you the money you require. Yes, of course we will want as security the deeds of your house, of your aunt’s house, of your second cousin’s house, of your wife’s parents’ house, and of your grannie’s bungalow, and we will in addition need a controlling interest in your new company, unrestricted access to your private bank account, the deposit in our vaults of your three children as hostages and a full legal indemnity against any acts of embezzlement carried out against you by any members of our staff during the normal course of their duties … no, I’m afraid we couldn’t accept your dog instead of your youngest child, we would like to suggest a brand new scheme of ours under which 51% of both your dog and your wife pass to us in the event of your suffering a serious accident.”
John Cleese, comedian (1939–), “Merchant Banker”, Monty Python sketch (British TV series, 1969)
Factoring may turn out to be an obstacle on the business’ path to expansion as traditional finance methods assume that the business will continue to be run in the same way and provide for the same type of clients. Those products lack the flexibility that is always required in the ever changing economic climate. In most cases, the traditional providers will have a degree of control over a company’s financial affairs by imposing ‘minimum factoring requirements’ and controlling its ledger.
Lenders impose concentration limits to mitigate risk, in cases when an invoice isn’t paid. As an example, if your concentration limit is 20% and your total ledger is £100,000, then the lender will only consider £20,000 of funding with any single debtor. Thus, in case of businesses that get the most of their revenue from one client, traditional invoice finance doesn’t substantially help with either cash flow optimisation or growth capital.
Traditional providers market themselves by using teasers that make their pricing seem very attractive. In reality, they charge a lot more by applying various costs that are hidden in-between the lines of your contract agreement, written in the smallest font size allowed by the law. Here’s some of the fees that you usually won’t see in a teaser but end up paying as a client: monthly minimums, add-on or administration fees, application fees, proposal fees, due diligence fees, credit check fees, notification fees, schedule processing fees, BACS fees, invoice processing fees and so on.
If you add requirements such as personal guarantees and debentures to the pot, instead of financial support you, as well as your business, are given a heavy burden. Once you start borrowing money against your invoices through traditional providers it is difficult to leave as you continuously borrow more while repaying your past debts. Suddenly, you become yet another cash cow to the banks and private lenders.
In today’s business world of rapid growth, expansion isn’t just an option but a means to survival. As Americans tend to say ‘you snooze, you lose’. To remain in the game you have to keep up with the competition. Until a few years ago, it was difficult for many companies to maintain a healthy cash flow while not becoming enslaved to the financial system.
In 2012 the UK Government began to invest in small businesses through alternative funding channels, hoping to bypass the mainstream finance providers that dominate the market and impose unfavourable terms, making access to funding expensive and unreachable for many enterprises.
Contrary to banks, those Government-backed providers offer a flexible and transparent solution. Funding is often available on the same day, with a quick online registration process and an immediate decision. There are no contracts, hidden fees or personal guarantees. The initiative of the British Business Bank (part of The Department for Business Innovation and Skills) helped hundreds of companies overcome problems that traditional providers wouldn’t address either because of their steep acceptance criteria or unaffordable fees.
While banks shield themselves from those who need funding most, increasingly more businesses turn to alternative providers for a solution to their financial challenges. As it was remarked by John Bevan, the former Royal Bank of Scotland and Barclays banker: “UK’s reliance on traditional funding cannot continue”.
So, if you remember to do one thing today, ladies and gentlemen – Break up with your bank