The top three operational decisions when launching a Factoring, SCF or Invoice Discounting Fund

Covid has wreaked havoc across the globe, disproportionately affecting certain geographies, industries and companies of different sizes. This has significantly increased demand for working capital solutions across the board, from micro institutions to multinationals.

As a result, the number of new, dedicated financing institutions (FIs) offering working capital solutions has been increasing faster than ever. Today we’re sharing our insights on the top three operational decisions FIs will need to consider in their early days.

Before we get there, who are we, and why do people ask for our views? Glad you asked!

Finverity is an award-winning Supply Chain Finance and Factoring technology provider headquartered in London and active in over 7 countries. We create tailored, white-label SaaS solutions for banks and NBFIs across emerging markets. Our solutions enable businesses to operate and scale their operations digitally with significantly enhanced risk monitoring, customer experience and operational efficiency.

Finverity provides best-in-class technology solutions combined with in-depth knowledge of payables and receivables. This powerful combination has led Finverity to originate a $500m SCF portfolio in emerging markets in only two and a half years. Finverity’s ethos is based on collaboration. Sharing the tools, knowledge and methodology gained from our experience is second nature to us. Ready to dive in?

1. Short Term Self Liquidating Alternatives vs Traditional lending

Most early-stage, credit-focused FIs start with a relatively loosely defined idea. At this point, most of such FIs have not secured sufficient capital commitments from investors. This can be along the lines of:

“I’m looking to lend capital to a specific target market, and I have a certain yield expectation, a certain tenor limit and in most cases, a preference in terms of industry sector.”

In 2021, however, most SMEs around the world took significant hits to their balance sheets. This directly impacted their ability to secure lending via traditional credit, given that their assets, revenues and overall indicators had weakened. When starting to originate clients, emerging funds often face data sets that differ significantly from initial expectations.

Thankfully, Supply Chain Finance (also known as Reverse Factoring) and Factoring can provide a solution. In essence, these are short-term, self-liquidating assets but offering a more tightly controlled version of short-term lending.

How and why is this relevant?

SCF & Factoring are significantly safer asset classes when compared to traditional lending. They are also easier to fundraise for when correctly structured and presented.

SCF and Factoring mechanisms allow a financier to also consider the credit risk of the SME’s buyer client. This is in contrast to focusing solely on the SME client’s credit risk, as is the case in traditional financing. In most cases, the SME’s buyer client entity will be larger, healthier and more “bankable”.

When an SME sells goods or services to a buyer client and issues invoices via SCF or factoring mechanisms, the invoices (or account receivables), the FI can finance these in order to provide much-needed working capital for the SME.

To scale up safely and build an SCF business, a number of procedures need to be implemented. One example is that each account receivable needs to be verified and confirmed with the buyer of goods or services. Despite the short-term and self-liquidating nature of this type of financing, key indicators from buyers and sellers need to be continuously analysed. Our favourite indicator is receivables ageing for both parties. If the buyer client is struggling to collect payments on its side, it’s most likely in turn to struggle to pay the SME.

2. What human resources will I need on day 1, and how do I scale my team? Or tech?

Until less than a decade ago, the answer to this question would have focused on the high levels of human resources and costs required. Most banks, and indeed NBFIs, that have been active in the SCF & Factoring space have established back and middle office functions in place. Their many employees perform monitoring tasks that are repetitive but incredibly important. But the last decade has brought dramatic improvements in processing technology and fintech resulting in much lower human resources requirements and costs.

The short answer, on day 1 you’ll need:

  • A compliance officer – this one goes without saying
  • A client relationship manager – taking care of onboarding and client queries
  • A middle office executive responsible for verifying invoices and trades between clients
  • A risk manager to assess counterparties’ risk, maintain limits and monitor financial indicators
  • A back-office executive handling payments, reconciliation and reporting
  • A manager / CEO. A job description is impossible to write because as an entrepreneur you will to do a little bit of everything

And surprisingly, that’s it.

A grand total of 5 employees and a “manager / CEO” is sufficient to operate an initial set of 6-10 clients in SCF/Factoring. We have seen good examples of funds scaling up to $50M in capital deployed with such a structure.

But how? That sounds like a monstrous amount of work…and it is. Thankfully, there’s a technological solution to automate and augment much of the work so that it becomes manageable.

Finverity provides an origination-to-execution technology solution for SCF and Factoring. Our white label solution digitalizes the entire process end-to-end. This includes digital customer onboarding screens incorporating automatic compliance checks, fully customisable workflows that ping your team members only when a specific approval or task is required to move a deal forward, automatic payments and reconciliation.

Finverity’s clients are therefore able to scale their portfolios faster and, most importantly, safer. Enhanced visibility and tighter control of risk is the result. This leads to happier clients with full, real-time access to digital portals providing all the information they need. Digitalization and automation also result in fewer staff required.

3. How do I create my internal risk and operational frameworks, and what should they be?

A consulting approach underlines Finverity’s approach to implementing each individual white label solution. Since no two clients are identical, we pride ourselves on never issuing two of the same solutions. We seek to provide what will work best and most efficiently for each client’s specific objectives.

Once the way forward is agreed, we implement controls and workflows that guarantee execution follows defined requirements. This includes a full audit trail of who took what decision and why internally.

Assuming that clients have already been onboarded, two main tasks need to be fulfilled before disbursement:

Invoice Confirmation – Verifying that goods have arrived to the buyer in the right quantity and quality. This requires verification that a satisfactory form of payment guarantee has been issued in favour of the financial institution, such as an Irrevocable Payment Undertaking (IPU), paired with a true-sale of the underlying receivable from the supplier. Finverity’s system will automatically generate these. In order to then “perfect the charge”, in most jurisdictions, a signed order form is automatically forwarded to the buyer of goods or services as a notification.

Risk Approval – There are two key levels of risk approval.

1) The initial client review is an in-depth credit due diligence process formed out of data collection and traditional credit underwriting with the goal of setting a price and a limit for the client’s facility if approved.

2) Ongoing risk monitoring is provided via collecting real-time data and measuring progress (such as receivables ageing profiles). Verification of individual invoices is at a frequency of the financial institution’s choice. Finverity’s system allows clients to customise the frequency of checks on each buyer-supplier relationship as well as to hard code a specific threshold limit over which additional risk approval is required prior to disbursal.

For both of the above tasks, the SaaS white label solution puts in place digital workflows and rules. This includes Maker-Checker functions, full audit trails, document upload capabilities with notes and comments and much more.

An honourable mention must go to the legal infrastructure required for trade finance, which naturally includes legal documentation. Money can solve 75% of this issue since experienced law firms will be able to provide the relevant draft agreements. However, in our experience, if law firms take a lead on this process, the outcome becomes overly complex and expensive, as well as counterproductive to business growth. As a result, one of the benefits Finverity’s ecosystem offers its users is access to the required legal documentation and structures at highly reduced rates.

Finverity was born out of a vision to make the global financial system work for all, one product at a time. The company is on a mission to enable the trade finance ecosystem in emerging markets to do better and bridge the $1.7trn global trade finance gap by channelling capital to where it’s most needed: mid-market companies in emerging markets, which make up the bulk of the gap. That’s why we are proud to be working with early-stage funds and local banks active in trade finance as an essential step in bridging the global trade finance gap.

Register for Finverity’s Emerging Leaders Programme here