There's a new way to sell receivables: on an exchange.
Keith Voigts has cash flow on his mind. As CFO of iSeatz, Voigts needs to make sure the $5 million company has enough cash to pay the bills. But New Orleans-based iSeatz, which arranges travel packages for clients like Orbitz and Travelocity, has no collateral for a bank loan. And its customers sometimes take 90 days to pay up. Voigts has considered factoring--selling the company's receivables at a discount to get cash up-front. In the past, however, he has always avoided it because of its high costs and bad reputation. "I wouldn't say it's a shady business, but there's a stigma to it," he says.
Now Voigts is taking another look. iSeatz will be one of the first companies to list its invoices on The Receivables Exchange, or TRE, which is launching in the first quarter of 2008. Founded by Justin Brownhill and Nic Perkin, TRE aims to change the factoring model altogether. The exchange will allow companies to offer their receivables to dozens of factoring companies at once, along with hedge funds, banks, and other "liquidity providers," in TRE's parlance. These lenders will bid on the invoices, which can be sold in a bundle or one at a time. The increased competition, Brownhill and Perkin say, will make it easier and cheaper for growing companies to raise working capital. "We hope to allow companies to grow quicker, faster, better than they otherwise would," says Brownhill, the exchange's CEO. So far, several dozen companies--"issuers," in TRE's lingo--have signed up, with annual revenue ranging from $5 million to $100 million.
Factoring is an unloved form of financing, at least in the United States. It's often used by companies with poor credit or by businesses such as apparel manufacturers, which have to fill orders long before they get paid. But it's an expensive way to raise funds. Companies selling receivables generally pay a fee ranging from 2 percent to 7 percent of the total amount, according to Bert Goldberg, executive director of the International Factoring Association. If you pay a 2 percent fee to get funds 30 days in advance, it's equivalent to an annual interest rate of about 24 percent. No wonder, then, that in the U.S., factoring is often seen as the corporate equivalent of a check-cashing storefront in a battered neighborhood.
The industry's reputation has improved in recent years. But Brownhill and Perkin want the U.S. receivables market to look more like the market in Europe. The factoring market is still relatively immature in the U.S., partly because only a few big American banks, including Wells Fargo (NYSE:WFC) and CIT (NYSE:CIT), are major players in the industry. For the most part, factoring remains a fragmented industry composed of many small players. Across the pond, by contrast, the major banks buy receivables. They tend to charge lower fees and offer a higher degree of credibility. In 2006, $127 billion of receivables were sold in the U.S., making it fourth in the world for factoring after the United Kingdom ($328 billion), Italy ($159 billion), and France ($132 billion), according to the trade group Factors Chain International. (FCI publishes the numbers in euros; we converted them using the exchange rate on the last business day of 2006.)
Brownhill and Perkin think Americans, given the right opportunity, would take to factoring much as they have taken to Ikea and H&M. Both co-founders know a thing or two about building businesses. Brownhill was an executive at Lava Trading, an equity and foreign exchange trading firm, and helped take it from 30 people to 300 before it was bought by Citigroup (NYSE:C), in 2004. Perkin, TRE's president, was head of global business development at Massive, a company that places ads in video games, until it was sold to Microsoft (NASDAQ:MSFT), in May 2006. The two have secured $4.2 million in financing from Prism VentureWorks and another seven-figure investment from Fidelity Ventures, an affiliate of the financial giant Fidelity Investments. Larry Cheng, a partner with Fidelity Ventures, says he was drawn to TRE's simplicity. "It's almost like eBay--post your invoice and let everyone bid on it," says Cheng.
The receivables industry has been jostled by a number of new players, bringing new models. The Trade Receivable Exchange, known as T-REX, was launched in May 2007. T-REX is an auction marketplace for all sorts of Chapter 11 bankruptcy claims. If one of your clients goes bankrupt, you could wait years for payment while the bankruptcy case works its way through the courts. T-REX allows you to get cash immediately by selling those receivables to hedge funds and other buyers, sometimes for pennies on the dollar, sometimes for almost the face value of the invoice. Another new company, Factorlane.com, is essentially a relationship broker that helps companies connect with factoring firms, known in the industry as factors.
But TRE aims to spur a major shift in the way the industry works. Unlike Factorlane, TRE allows you to sell just one receivable. Suppose a customer owes you $100,000 but won't pay for another 60 days--and you need cash now. Traditionally, you would shop around for a factoring provider, going through due diligence several times before settling on one company and developing a relationship. But with TRE, you have to go through the due diligence process only once, with the exchange. After you register your company online and upload your financial statements, TRE spends up to two weeks checking your credit rating, looking for unpaid debts, and searching bankruptcy records.
Once your application is approved, you can put up your receivables for bid. For that $100,000 invoice, you could get $98,000 or much less. TRE allows you to set a minimum bid, and if none of the bids reach that minimum, you can reject them all. But if the highest bid beats your minimum, it's automatically accepted. The winning lender sends the cash through TRE, which takes a commission of .25 to .5 percent. Six weeks later, when you receive payment from your client, you repay the factor the full $100,000--again through TRE, which takes another commission. You have essentially taken out a loan, with your receivable as collateral. The transaction is classified as a sale, not a loan, under Louisiana law. Nevertheless, unpaid accounts could land at a collection agency and would show up on your credit report.
Brownhill acknowledges that factors have some security concerns. They worry about buying fake invoices and may be reluctant to let TRE do their due diligence for them. Also, some factors are wary of letting the exchange disburse funds. "They're going to have to be able to do that efficiently and securely, so the liquidity providers know their investments are being monitored," says Pat Haney, president of Commercial Capital Lending, a factor in Baton Rouge, Louisiana. TRE's founders hope the benefits for factors--a steady supply of high-quality receivables--will outweigh the potential downsides. And despite their concerns, Haney and about 10 other liquidity providers have decided to give it a shot.
The exchange faces other hurdles as well. Factoring has long been based on relationships; companies often form a partnership with a single factor, which purchases invoices on a regular basis. TRE may introduce factoring to a previously cynical group of business owners. But once they learn to love factoring, those companies could look outside of the exchange for a long-term relationship. "Companies that sell receivables are looking for trust," says T-REX founder David Williams. "An auction thrives when it's based only on price."
But Voigts, at iSeatz, says he's looking for a good deal, not an ongoing relationship. "I'd like to have the ability to have everybody bid on it," he says. Indeed, Brownhill thinks TRE's system will be too good for business owners to pass up. "We would like to think we're creating such a competitive environment that putting it up for bid is always the best way to do it," he says. "It's putting control back in the hands of the CFO."