Not all business either want or are ready for first and second-tier bank finance. Some businesses need finance but are not “bankable”. Let’s take a look at why this might be.

Reasons for choosing debtor finance

  • An inability, or reluctance to provide the security a bank will require. Sometimes, due to the nature of borrowing, a bank will request a mortgage over personally owned residential or commercial real estate;
  • A recently started business in high growth mode, with minimal business equity;
  • An established business, which has had adverse dealings with banks in the past. Or a business that understands the difference between its funding options and has determined that access to working capital via its client debtor book is a practical funding option.
  • A business looking for merger and acquisition opportunities, and which has the ability to unlock the capital/cash in its accounts receivables ledger to assist with acquiring that new investment.

So, how does debtor finance work? How much can be borrowed? What does the finance provider charge? And what security will be required?

How debtor finance works

The essence of debtor finance is to take a customer invoice for goods or services provided – you receive 80% of that invoice in cash, via a debtor finance facility. The cash is available from the day the invoice is sent to your customer so you don’t have to wait 30-45 days for payment.

You receive the remaining 20% when the client pays their invoice.

Debtor finance generates instant cashflow from your customer invoices and therefore precious working capital. For which you pay interest, and a monthly management fee depending on the type of Funding Facility chosen.

To set up a debtor finance arrangement, a Debtor Finance Facility Agreement is needed.

Debtor finance focusses on financing a customer invoice. The agreement outlines the mechanics of the debtor finance facility which will include the likes of the facility term, payment percentage of invoice (usually 80%), proof of delivery requirements and recourse terms.

What does the finance provider charge?

Interest is charged at rates comparable to a bank overdraft interest rate, sometimes below it. The interest cost is charged on a number-of-days basis, at the agreed annual interest rate, for the period between the date of the invoice and the date that your customer pays you for the invoice.

In addition to the interest, there is a management fee to set up the debtor finance facility, which includes a minimum usage fee per month.

Both fees are standard practice and defray the costs that the finance provider incurs.

The total costs of the interest, the facility fee, and the minimum usage fee are in line with bank overdraft funding costs. It provides a realistic and cost-effective option for working capital finance to a business that doesn’t want or can’t access bank finance.

What security will be required?

GSA over the business and/or first ranking security on debtors

A General Security Agreement (GSA), in this case, is focussed on the finance provider receiving a first-ranking GSA over your debtor book. This is understandable, as the debtors within your business provide the basis of these financing transactions.

“First-ranking” means that your finance provider is not subordinating their security to any other party.

So, even if there is an existing GSA from another creditor, as long as the Debtor Financier has First-ranking priority on the debtors, that is acceptable.

Personal guarantee

This is a business transaction so the finance provider will require the owner(s) of the business to personally stand behind and guarantee the finance facility. This is a normal practice. Also, one of the reasons the rate of interest charged is moderate and competitive with other sources of finance. It is certainly less expensive than unsecured financing options.

What types of debtor finance facilities are available?

There are two main types of facility. A disclosed facility and an undisclosed facility.

How a disclosed facility works

Your customer is aware you are financing their invoice via a third party finance provider.

This type of debtor facility is normally associated with a credit management service from the finance provider. They manage the collection of the invoice on your behalf.

This option can suit a business owner who:

  • Has no issue with customers being aware that debtor finance is being provided.
  • Who lacks the skills, inclination and desire to manage the credit-control of their debtor ledger.

How an undisclosed facility works

Your customer is not aware you are financing their invoice via a third-party finance provider.

This type of debtor facility does not come with a credit management service from the finance provider. Instead, you manage your debtor book, taking care of all credit management processes to ensure your company is paid by its customers.

This option can suit a business owner who:

  • Prefers customers to remain unaware that debtor finance is being provided. There are many reasons for this, the key point is that it is up to you as to whether you wish to have an undisclosed facility.
  • Has the skills, inclination and desire to manage the credit-control of their debtors’ ledger.

How do I set up a debtor finance facility, and which provider should I use?

Selecting a finance provider, engaging with them and working through the approval and operation of a debtor finance facility requires advice from an experienced business advisory professional.

I have a great deal of experience in this area and regularly advise clients on a range of funding options, including debtor finance facilities.

There are a small number of quality finance providers in this space. Advantage Business works closely with ScotPac, a well-qualified and established debtor finance provider. ScotPac provides a personal and confidential service throughout New Zealand and Australia.

If you would like to discuss your needs in confidence, please complete the form below and we will be in touch.