Liability: It's Not Personal.

Most firms that buy individual invoices routinely obtain a personal guarantee of the seller’s obligations from one or more individuals associated with the seller.

If the transaction goes bad, the personal guarantee can become critical in ultimately recovering the money advanced for the invoice purchased. One of the reasons is that, if litigation is required, the litigation process can take so long that other pledged security, such as other receivables and other financial assets, can be long gone by the time there is actually a judgment for the buyer to attempt to enforce.

The Receivables Exchange does not obtain personal guarantees from its Sellers. So the Buyers’ avenues of recourse in the event payments are not properly received are more limited.

Why would personal guarantees not be obtained by TRE and what are the implications?

I think there are a few pretty obvious answers to the first question.

1) TRE aims to become a very large-volume marketplace. As a practical matter, scaling up gross transaction volume requires two components: a) more Sellers, and b) larger average transaction sizes.

2) Larger average transaction size implies larger Sellers and the larger and more substantial the Seller the less likely its principals will be willing to provide personal guarantees.

3) In order for a personal guarantee to affect a Buyer’s assessment of risk, the substance of the guarantee would have to be known to the Buyer. Few individuals, especially owners or principals of more substantial Sellers, would be willing to have their personal financial information made broadly available to Buyers with whom they have no direct relationship and over whose use of the information they would have little effective control.

As to the implications, again, I think there are a few.

1) Analysis of the Seller’s financial condition and capacity becomes more critical. If a payment is not received for a purchased receivable, does the Seller have the ability to make good the Buyer’s loss?

2) Analysis of the validity of the receivable proposed for sale, which is always critical of course, becomes even more so.

3) Analysis of the Account Debtor’s capacity to pay and likelihood of paying the invoice likewise becomes more critical.

4) In short, when one source of security is removed, all of those that remain become more important.

I think it’s quite understandable that TRE does not obtain personal guarantees from its Sellers. But that doesn’t mean that there is no impact on risk assessment. And if there is an impact on risk assessment there should be an impact on pricing.

It does mean that analysis of the Seller’s financial condition, the validity of the invoices posted for sale and the ability and likelihood of the Account Debtors to pay those invoices, all take on heightened importance.

If analysis of the Sellers' financial condition becomes more important, reliability of the financial information provided (or otherwise available to Buyers) is key.

In our next post we’ll discuss the issue of the level of assurance that can be attributed to information in various types of Seller financial statements.