The contagion effect, COVID-19 and invoice finance

Before the world stopped to battle the invisible global COVID-19 outbreak, a number of source-to-pay (S2P) platforms were trying to crack the code on developing receivable finance beyond buyer-approved invoices contained on their platform.

The idea went something like this. “Let’s target major buyers’ suppliers on our platform. Using extraction capabilities, we can pull information from the supplier’s accounting system and other sources. We can develop underwriting guidelines, possibly using a third party, and start providing some form of receivable finance beyond the sellers’ invoices on our platform. We can even take a first loss on any funding in the deal, so a potential financial servicing and/or funding provider would be attracted knowing we have first loss.”

Essentially, S2P platforms wanted to go beyond their own closed-loop system and broaden their receivable finance offering to include, potentially, when invoices are submitted and when invoices have been verified, but before they have been approved for payment. Under either approach, the risks are much greater than the buyer-approved invoice technique.

1. Invoices submitted have the highest risk. For example, a fraudulent invoice could be created or mistakes can be made, i.e., double billing, etc. (See: Why fraud scares investors buying invoices)
2. Invoices verified, which essentially means the buyer confirms receiving the invoice, can suffer from dilution, i.e., where some deduction is made off the invoice value for many reasons. In fact, when factoring organizations lose money, it’s typically not because Sears or Kmart goes bankrupt (they may in fact have credit insurance for this event, or they have long smelled this coming and stopped funding these invoices), it’s because of dilution.

While there is a lot of innovation happening around this space and new players have entered, such as Raistone Capital, Previse, Tradeshift and others, the risks involved are highlighted in the black swan event we are experiencing now from the coronavirus disruption.

No one knows how long the devastation to business will ripple through multiple industries. Underwriting models can’t possibly take into account what happens to a supplier where shortages develop or its credit line runs dry and it can’t fulfill orders or has a major packaging problem. This could turn into short deliveries, late deliveries, etc. and cause a contagion problem throughout that  business. Customer service starts to deteriorate, and tough choices have to be made. This kind of problem could spiral out of control.

And just when we believe we have flattened the COVID-19 curve, COVID-20 pops up in the winter.

The point is that providing receivable finance as a technology company poses risk precisely because the potential outcomes are overwhelming and cannot be predicted, no matter how good the underwriting. We risk being fools of forecasts built on historical cash-flow expectations, modeling and simulations, machine learning, etc.

Without some government backstop, attempting to do wide-scale lending of this sort could be very dangerous for a technology company. EXIM recently rolled out a government guarantee on supply chain finance to help that market, especially for non-investment grade companies. The reality is just because you have the data from an S2P platform or marketplace network, can see historical transactions, believe you can ring-fence and manage the risk is precisely when contagion effects can rear their ugly head.

David Gustin runs Global Business Intelligence, a research and advisory practice focused on the intersection of payments, trade finance, trade credit and working capital. He can be reached at dgustin (at) globalbanking.com.