DAVID GUSTIN, Chief Strategy Officer, The Interface Financial Group
November 20, 2018, Source: Spend Matters
I often get this question about how factoring and supply chain finance differs from traditional invoice finance. And the real answer is it’s very murky. There is certainly a blurring between invoice finance, invoice discounting, factoring, supply chain finance, and asset-based lending.
By whatever name you want to call it, what really matters is what usury laws are governed by the lending technique and how bankruptcy court will interpret the structure (loan, asset purchase) and what the state or legal jurisdiction laws are in relation to the technique. Definitions are fine to help educate and illustrate, but they are meaningless when it comes to judges and investors.
I have written about definitions before when the ICC spent considerable time defining supply chain finance and other techniques. The objective was to help investors understand an asset class, but the reality is supply chain finance is a private placement market where definitions don’t matter — but credit and operation risk do.
To give an example, consider recourse factoring. In four U.S. states, if you purchase invoices on a recourse basis (meaning if the account debtor does not pay, you can go back to the borrower to claim funds), this is considered lending, not invoice finance, and you are subject to the same licensing and usury laws as lenders.
When you look at the textbook and historical definition of factoring, factors control the administration and collection of receivables. They offer a few key services to the seller:
- Ledger management relating to the receivables
- Collection of receivables
- Credit cover against default by the buyers
In factoring or asset-based lending, the funder undertakes credit management and collection of its clients’ book debts, whereas with invoice discounting, a business collects its own book debts and typically the receivables are assigned to the factor, and notice of assignment is served on the buyers — by way of an introductory letter, assignment clause on all invoices and statement of accounts from the factor.
Factor’s shift risks that they do not assume back to their client via chargebacks and indemnities. For example, in full recourse factoring, language in contracts can state that in the event any purchased account is not paid and collected within 120 days of invoice for any reason, then the factor shall have the right to charge back such account to seller.
Now we have other early pay finance techniques, such as digital supply chain finance, that have an advantage over these traditional methods of financing suppliers like factoring or invoice discounting because many operational costs are eliminated through the use of fast and big data.
Beyond the definitions and fancy names, we need to be cognizant of how various lending and asset purchase techniques work from an operational perspective, and what laws govern the transactions, and how bankruptcy courts will treat the request to recover funds. This does matter!