Receivables Financing

Do Your Homework and Reap the Benefits

The execution of business to business (B2B) customer open accounts receivable (AR) financing can be a minefield, so it is vital to prepare adequately for such a facility from all angles. Below is an outline of general steps recommended for a successful initiative – including the critical questions to ask both internal teams and external partners.

In light of the current challenging macroeconomic environment, AR finance solutions can be a great way to gain gain access to cheaper cost of funding, non-recourse and or off-balance sheet treatment, diversification of funding, access to a different liquidity source, and an improvement in working capital metrics.

Common receivables finance products include:

• Receivables monetisation – suitable for a concentrated customer pool of only a few names wherein the credit risk analysis is generally on a customer-name-by-name basis.
• Receivables portfolio purchase – appropriate for a somewhat more diverse pool of customers and typically uses credit insurance for risk mitigation. Factoring and invoice discounting facilities tend to fall under this category.
• Receivables securitisation – generally suitable for a fairly granular and diverse pool of customer receivables of at least $50m^[1] without significant concentrations.
• Buyer’s supply chain finance (reverse factoring) – supply chain finance (SCF) programmes to which suppliers sign up to generally leveraging the credit rating of their buyer, for cheaper financing rates and additional liquidity.

When considering AR financing, thinking and planning ahead goes a long way towards smooth execution. Here, we examine the steps that can make a difference.

Clearly defining the objectives

This is the first stage and provides useful guidance to solution providers (such as advisers and funders) as to what you are seeking. You might be looking for one or more of the following: additional liquidity, a reduction in financing costs, ways to support the supply chain, risk transfer, off-balance sheet treatment (under the appropriate accounting regime), inclusion of some or all debtors, more centralised and efficient financing, etc.

Doing the homework

There are also benefits to be gained from assessing the gaps in certain areas that may require preparation or early action. As such, key steps when for preparing for AR finance include:

1. Carve-outs in loan (existing facilities’) documentation
2. Defining the scope
3. Data readiness
4. Building an understanding of your customer contracts
5. Building some understanding of your customer portfolio risk
6. Collection accounts
7. Operational suitability

1. Carve-outs in loan documentation
This is the starting point when considering receivables purchase facilities. These questions must be answered:

• Does the documentation of any current debt facilities in place allow for the sale of trade receivables?
• If yes, up to what amount? Does it restrict your ability to utilise your AR fully or in part, for financing? If there is a carve-out for such financing in your senior facilities’ documentation, receivables can be financed only up to that amount.
• If not, can such a carve-out be negotiated with the senior lenders at the next refinancing opportunity? It is advisable to take legal advice for the drafting and negotiation of a carve-out.
• Are there any other restrictions in the documentation to prevent you from considering a trade receivables financing?

For companies that are acquired by private equity or sponsor firms, it is especially important to include the relevant language around this topic when the acquisition facilities are being put in place.

2. Defining the scope
Alongside the objectives above, you would also need to determine the scope of a receivables financing programme by taking a closer look at the corporate group structure in order to provide guidance to solution providers. First, pinpoint which of the corporate entities can be considered for inclusion in such a programme.

• How many operating entities that sell to external customers can be considered?
• What is the volume of accounts’ receivables from these?
• Which jurisdictions are they based in and are there any existing receivables or debt facilities?

The AR volumes and jurisdictional location can provide a first indication of the potential pool of receivables that can be included in a programme. If your company is making an acquisition in the near future, it would be prudent to do the same for operating entities of the target to ascertain its contribution to a combined receivables financing programme. With the objectives and scope defined, you can move to the next steps.

The success of a receivables financing project also depends on appropriate resource allocation, both internal and external.

 3. Data readiness
Receivables facilities are heavily dependent on historical data during terms’ negotiation and its reporting on an ongoing basis. It is relevant to look at what data in relation to third-party invoices is available in the enterprise resource planning (ERP) system in relation to AR’s performance. Is the data consistent across entities and do they even use the same ERPs? Depending on the terms of your facility, there can be parts of data that can bring ‘surprises’ in relation to funding availability under a facility. These can include counterclaims or offsets (where your customer is also a supplier), progress or milestone-based billings, unearned receivables, rebate or promotional discount accrual liabilities, advances or deposits from customers, and consolidated exposures to a single customer group via multiple relationships at subsidiary level on both the seller’s and buyer’s side.

4. Building an understanding of your customer contracts
In receivables financing facilities in particular, the customer contracts are carefully assessed during due diligence. At the time when a facility’s terms are being negotiated, the following questions will have an impact on what the eligibility criteria will be and how much funding can be expected. In-house legal teams generally take a lead in analysing the answers, sometimes with help from external counsel as well, but advance knowledge can make a tremendous difference when facing tight timelines. Questions to ask include:

• Are the contracts global or separate for each of the operating subsidiaries? Similarly, is there a central contract with a parent entity of a customer group or different ones with different subsidiaries of the customer?
• What is the governing law of a customer contract? It is possible that the governing law in an agreement with a large customer may be dictated by that customer’s location, which may be outside the seller’s country. This, in turn, may have a bearing on whether the asset can be sold to a funder and what additional legal arrangements need to be put in place.
• Are there any restrictions prohibiting receivables sale arrangements (e.g. restrictions on assignability^[2] or confidentiality)?
• Additionally, is it clear whose (seller’s or customer’s) terms apply, in case of unwritten contracts, as that may lead to a dispute or what is often referred to as the ‘battle of forms’? This is especially relevant for the biggest customers, in terms of AR exposure, who will be analysed more closely during due diligence.
• Finally, is your company already seeking funding of invoices from SCF programmes of any of its customers?

5. Building an understanding of your customer portfolio risk
To do this, you should consider the following points:

• What does the customer pool look like? Is it concentrated or diverse?
• How many customers are there?
• How many of the most important customers are investment grade?
• What does the credit profile of the top customers look like?
• Are there any names subject to sanctions or based in such locations?
• Are there government entities or individual debtors on the list?
• Is there credit insurance in place? If so, what are the terms of credit insurance? Is the credit insurance separate for different operating entities or is it a global contract?
• How are the customer credit limits set and monitored internally within your own company’s systems?

6. Collection accounts
Funders typically take direct or indirect control of collection accounts in such facilities. Consider:

• What does your collection account structure look like?
• Is your AR  collection activity separate from other types of incoming and outgoing cash? It is highly advisable to keep collection accounts segregated from other activity, which makes it operationally easier to execute receivables finance facilities at the right time.

7. Operational suitability
There can be many details to examine under this topic, such as:

• Does your company have a written credit and collections policy?
• Are there adequate customer onboarding and credit monitoring procedures in place?
• Were there any findings around receivables management under the last internal/external audits conducted?

Any corporate planning to explore such facilities should generally review their operational capabilities around activities including receivables management, credit and collections procedures, and the use of adequate information systems to provide the required reporting. All of these are assessed by funders in their due diligence process to ensure the proper servicing of assets, as this responsibility typically remains with the seller.

Finally, the success of a receivables financing project also depends on appropriate resource allocation, both internal and external. Receivables financing, especially if carried out for a portfolio spanning across operating entities and jurisdictions, can be easier to set up if an internal project manager is identified. They should be allowed to spend adequate time on the execution of the project and given backing from senior management. This will facilitate the timely onboarding of various stakeholders within the organisation. External partners such as independent advisers, reporting solution providers, and legal counsel also play an important role in supporting a smooth and successful transaction execution.

The author would like to acknowledge François Terrade, Global Head of Structuring, Demica, for his valuable feedback on the above.