For now peer-to-peer finance providers are most frequently judged by the volume of their lending, but in time the quality of that lending will be what counts most. At Marketinvoice, because our loans are short duration (40 days on average), we have a level of insight into the quality of our risk modelling that is not available to other peer-to-peer finance providers.
Over the course of a few blogs I will share some of that insight.
This blog will look briefly at some of the broader considerations of risk in invoice discounting, two subsequent pieces will consider specific elements of risk more closely. Any examples I use will be entirely fictitious.
How invoice discounting is supposed to work
Before going into the details of what can go wrong, let’s try to understand all the things which can go right.
First, let’s start with a young company producing marketing videos called MaVi. MaVi produces a video for a company called Chem Ltd, producing chemicals. After delivering the videos, MaVi writes an invoice to Chem asking them to pay within 40 days, which they approve.
In the meantime, MaVi want to do a new commercial for a different customer. To fund the salary for the actors in the new video MaVi would like to receive the funds from Chem today. MaVi sells its Chem invoice to investors through MarketInvoice, which enables them to receive the funds immediately in exchange for the future payment of Chem excluding a small discount.
After 40 days MarketInvoice receives the payment from Chem and settles the debt of Chem to the Investors.
What can go wrong in invoice discounting?
The main risk for the investors is that Chem does not pay off the debt after 40 days. There are multiple reasons why this might happen
There might simply be a delay in the payment of Chem Ltd and it is going to arrive at a later time. This is called an
the contract. For example Chem might say that MaVi only delivered 3min of video, but promised 4min.
Chem might have confused the payment details and paid MaVi directly, this is called
Chem might become
in the time it takes to settle the invoice.
How do we mitigate risk?
Application: Before being allowed to login to the MarketInvoice platform businesses are required to submit an application form and undergo fraud and credit checks. We consider a wide range of data in assessing these applications, from trading history to the LinkedIn pages of the company.
Verification: Before a trade is launched, MarketInvoice attempts to contact the customer (such as Chem), this can pre-empt contractual disputes and ensure the invoice is paid into the correct account.
Advance Rate: If the customer disputes the debt, one can often reach an agreement involving a cut in the outstanding debt. To protect the investors from that cut, only a fraction of the debt is advanced. Advance rates also mean that businesses still have ‘skin in the game’ after raising finance against an invoice. Our lending model enables far higher advance rates (75% - 90%) than those available in traditional invoice finance (usually around 50%).
Limits: To ensure that the client can repurchase the debt from the investors, we make sure that each client only receives funds which he can repurchase and so we set a limit on the total amount of outstanding payments a business can have at any given time.
How do we collect when something goes wrong?
Now let’s consider that Chem Ltd, for whatever reason, does not pay the debt. Then MarketInvoice asks MaVi to pay instead of Chem. There are two possibilities:
MaVi is able to make this payment
MaVi tries to pay
It’s important that insolvency of MaVi in itself is not a problem as long as Chem is still paying. Unfortunately, Chem’s declined payment is often directly related to the solvency of MaVi. For example, disputing value of the video often indicates that MaVi does not produce a good product and might therefore become insolvent.
When MarketInvoice is not able to receive a payment from the customer, the client is asked to repurchase the debt. Usually, the client is able to repurchase the debt and settle the transaction with the investors. The client might be insolvent and therefore unable to repurchase. MarketInvoice aims to recover as much as possible in the proceedings.
MarketInvoice has been very successful at protecting the money from investors. Only 1.9% of trades have fallen into default (which means they were not paid for at least 45 days beyond the expected payment date), and from those defaulted trades we have collected over 96% of funds.