Workshop: Commercial: invoice finance

The opportunity for clients to raise funds either on mortgages or by entering into long-term loans other than at exceptionally high rates of interest, combined with the seeming reluctance of the clearing banks to extend overdraft facilities has meant clients are now looking at options which they might previously have ignored or thought wholly inappropriate to their businesses.

Such new options may be tempting but caution needs to be exercised to try to ensure that clients don’t end up taking on excessive debt at unaffordable rates.

Quite simply clients can find themselves walking into potentially very expensive deals in all innocence especially where only a flat rate of interest is shown rather than the true APR and where high arrangement fees are not uncommon.

Payday lender Wonga recently launched a loan service offering small and medium enterprises short-term loans of between £3,000 and £10,000 “within 15 minutes”. Interest rates start at 0.3% but they rise to 2% for businesses with poor credit records. There are also arrangement fees, and it has been calculated that SMEs could end up paying 106% on the sum borrowed.

There is a tried and tested alternative to such financing, which many clients have not explored and which might be suitable: invoice finance.

Invoice discounting or factoring – the more traditional name of ‘invoice finance’ – provides a short-term finance function which, if used astutely, can be more flexible than traditional forms of finance and cheaper than some of the new entrants to the market.

Invoice finance releases the monies from unpaid invoices and ensures cash flow is freely available within the business. As a subject on which lawyers are increasingly being asked to provide guidance some key points need to be kept in mind especially since a number of the agreements contain personal guarantees.

The marketing message from finance houses is simple: use invoice financing to release up to 85% value of your invoices within 14 days from invoice. While invoice discounting packages may well provide flexible finance solutions, allowing each client to retain control of the most important assets namely the sales ledger and customer base, one needs to first check to ensure the client’s bankers have not already taken a charge over book debts. Also check whether the proposed arrangements might breach other business agreements whether with another finance houses or indeed under a shareholders agreement.

You would also need to look for the min-imum period of the agreement and the notice provisions to avoid agreements rolling on for a further unexpected period: is an obligation on the client to invoice discount all their book debt or can one be selective?

One of the principal causes of concern for businesses historically is that they did not want their customers to even be aware of their need to raise finance on their invoices

Disclosing assigments

Yet in recent years the propositions from finance houses has become more sophisticated, allowing facilities to be ‘disclosed’ in the form of a notice of assignment on each invoice or – and this is the option which clients find more attractive – ‘confidential’.

The former has advantages, as customers are more likely to pay a factor, who is likely to be tougher in their approach in recovering monies for many clients. But it can be a real turnoff for businesses who have been concerned it could damage their goodwill.

‘Confidential’ or ‘discrete’ invoice discou-nting facility inevitably requires higher levels of financial stability and sales ledger performance but in many cases may be preferable for the client able to satisfy those criteria.

It is important to point out to clients that, effectively, invoice discounting only provides a one-off injection of cash, since once a block of historic invoices have been discounted (in reality borrowed against) there will be no new injections of funds until the client is able to issue new invoices which are accepted by the finance house and paid against.

While an immediate cash flow injection may be attractive, clients need to recognise that invoice discounting is not an panacea for all ills. It is important to work with the client’s accountant and demonstrate to the client the true cost of factoring so they can identify the long-term effect on both margins and profitability.

Moreover the majority of finance agree-ments require a business to undertake to buy back any debts which remain unpaid after 90 day period, which can result in the business being faced with an awkward situation where they thought a customer had paid, only later to find out the debt is unpaid and the business has to endeavour to recover the debt himself.

It has also become increasingly common in recent years for invoice financing companies to require a personal guarantees from one or more of the directors or shareholders that in the event that the client company is unable to meet its obligations under the agreement between the client and the invoice factoring company, whether because the invoices are uncollectable as a result of customer’s failure to pay the invoice of which the bulk was already been advanced to the client company or because the clients may have failed in their obligations to their customers or the business has collapsed entirely; a difficult subject but a really important one to discuss with the client.

Invoice discounting certainly works for many business entities but it is an area that needs careful consideration when as lawyers we are advising as to whether it is an option that is right for a particular client.