How Invoice Finance Works
Businesses sell goods and services on standard payment terms such as 20th of the following month or 60-day terms. They invoice once the goods or services have been provided to the client or completed. By nature, their client base is spread so they don’t have all their eggs in one basket.
The risk to the business is that their debtors may defer paying invoices while waiting on revenue, or the debtors’ payment terms may be longer than usual. In the meantime the business still has their own bills to pay and therefore could fall short on cashflow.
In the case of invoice finance, the business may look to borrow up to 80% of the value of their spread debtor’s ledger where all goods or services have been delivered. This is in order to help mitigate their shortfall between their debtors and creditors.
Debtors’ payments are paid directly to Lock Finance as the means of repaying the facility and then new funds are re-drawn against new invoices as they come in.
On behalf of Zagga investors, Lock Finance manages the lending and completes all due diligence on every loan, utilising over one hundred years of experience. Funding for these loans comes from Zagga investors, through the ‘Peer to Peer Factoring Fund’.
The risk to Zagga investors is mitigated in a number of ways:
- The borrowers’ product/services have been delivered therefore it is highly likely that a debtor will pay their invoice.
- A spread ledger means that if one or two debtors do not pay then the borrower will be able to wear the bad debts.
- Debtors make their payments directly to Lock Finance who controls the cashflow and releases money to the client against new invoices that are issued.
- The value of a commercial invoice retains its security value, i.e. it doesn’t depreciate and, is not subject to an industry downturn.
- More that 20% of a spread debtors’ ledger needs to be taken as bad debt for the investor to be at risk of losing any money.
- Zagga investors have a maximum risk exposure of 60% (LVR) of principal and unpaid interest, through a 20% security buffer and Lock Finance also taking the first 20% of risk.
A bonus aspect of invoices as security, is that it includes a specific charge and ranks the investors ahead of preferential creditors or General Securities. Therefore, the investors get paid first ahead of anyone else.
The investors also take a General Security so that, if required, other assets can be liquidated and a personal guarantee further helps to cover any potential shortfall.
Lock Finance completes a thorough risk assessment on every borrower and their situation to ensure they’re eligible for borrowing. This process includes:
- A meeting or discussion with the prospective borrower to make sure that the business fits the primary requirement - to ensure that Lock Finance fully understand the terms and the transactions with which the company operates. Do they sell a simple consumable product or provide a complex service? This will determine how easy it will be to collect debts if required.
- Lock Finance review the borrowers’ debtors ledger to make sure we understand exactly who the debtors are (quality), aging (how well they pay) and concentration (they don’t have all their eggs in one basket).
- Then Lock Finance reviews the prospective borrowers’ financial information to understand their profitability, balance sheet structure, creditor position and IRD position. Once they have that knowledge, they can drill down to understand the main business drivers and any weaknesses that may require appropriate adjustments to mitigate any weaknesses.
- Lock Finance complete the appropriate credit/PPSR checks on both the prospective borrower company and Directors.
- All new lending is approved by a formal credit committee to ensure the loan meets their credit policy criteria.