Post-Confirmation Dilution in an Uncertain Credit World


“There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns — the ones we don’t know we don’t know.”

There is a Zen-like quality to Donald Rumsfeld’s 2002 statement when he was the U.S. Defense secretary, but in business, an approved invoice can sometimes not be paid in full. This phenomenon is called “post-confirmation dilution,” or  invoices that have been scheduled for payment but are nonetheless not paid in full. Specialty lenders and fintech platforms have been addressing this primarily using some buyer guarantee without underwriting to predict post-confirmation dilution. This could cause some surprises in an uncertain credit climate.

How long has this benign credit cycle been going on? How about since 2008, when the Fed began dumping money into the economy to go way beyond its mandate as a last-stop liquidity gap. This has led to many distortions in the credit and capital markets, and one area where this is poorly understood is around “approved” invoices.

Despite what many players in the space might believe, underwriting is necessary — even  critical. Even though the invoices that are on the platform are, by definition, approved for payment (i.e., highly de-risked), they are by no means risk-free.

Just because a buyer approves an invoice does not fully guarantee payment will be made 100% on the invoice value. Up until buyers send their payment file to a bank or third party to remit funds via ACH, check, card or wire, they reserve the right to dilute the invoice value. The technical term is “post-confirmation dilution.” There are many reasons for post-confirmation dilution: a credit memo for some other invoice on the same payment date, buyers change their minds, taxes, disputes, and counterclaims or chargebacks.

There are “early pay” finance lenders that do one of two things to manage this:

  1. Ignore it, and take the risk of dilution. What this first group of companies has in common is that they essentially choose to assume away these risks. This group will learn this is an accident waiting to happen in a down credit cycle.
  2. The second group uses a guarantee that is provided through a document called an irrevocable payment undertaking (IPU) or a promissory note. But buyers don’t like it  because it limits their rights to not ultimately pay an invoice in full that’s already scheduled for payment and it can have accounting implications based on their auditors’ interpretation of their agreement.

My discussions with specialty lenders and fintech platforms doing early pay have indicated that post-confirmation dilution can range from 1.5% to 5%. When you think about this for a minute, if you are lending without an IPU or promissory note from an obligor (known as the buyer) and they short-pay you, this is equivalent to a loss of up to 5 cents on every $1 lent. Not good.

There is another way — and that involves underwriting to predict post-confirmation dilution. The buyer would have no guarantee agreement with the lender, and the early payment program is offered to all suppliers. There are no changes to the buyer’s payment terms. Buyers retain rights to chargeback, setoff, counterclaim or withhold payment, and the “early payment” program does not compete with and is complementary to a buyer’s dynamic discounting service. This involves technology and underwriting.

Remember: Factors don’t lose money for credit reasons, because they are usually working with good obligors, but because of disputes.

We are still in the early days of such initiatives, but as commerce increasingly digitizes and multi-enterprise supply chain collaboration platforms become the norm, new digital supply chain finance lending opportunities have the opportunity to flourish.

David Gustin runs a research and advisory practice centered on helping financial institutions, vendors and corporations understand the intersection of trade credit, payments and the financial supply chain. This post was written while David worked on a special project with The Interface Financial Group. He can be reached at dgustin (at)

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