Monday, November 30, 2009

Half a Bubble Off Plumb!

In my “Happy Anniversary!” post of November 23, I wrote:

From my point of view, the Exchange has tilted significantly toward the Seller community as it has attempted to bring on sufficient product to meet its volume targets.”

The degree of tilt is probably more than just “half a bubble”.

What has the Exchange done to “tilt” the playing field to favor the Sellers?

First let’s review where we began. From inception TRE:

--Has not required personal guarantees from the principals of Sellers,

--Has filed UCC Financing Statements encumbering ONLY the receivables sold on TRE (as opposed to getting a blanket lien on all receivables), and

--Has accepted internally-generated financial statements, frequently without any evidence of independent review.

Since the Exchange’s operations began, there have been a number of changes in policy or process that are good for Sellers but bad for Buyers.

What are some of those changes?

--Initially, invoices were to be verified by a third-party service provider. Now, the Exchange itself handles verification.

--Initially, the verification process was to include confirmation that goods had been delivered or services performed to the Account Debtor’s satisfaction. Now, verification is limited to obtaining confirmation that there is an invoice in the Debtor’s accounts payable system that matches the number, date and amount of the posted invoice. No actual affirmation of satisfaction is obtained. (Note that invoices from members of The Ariba Network do meet a more stringent standard.)

--Initially, all invoices were to be verified. Now, there is a sampling system.

--Initially, progress billings, which are common in the construction industry but present unusual risks, did not qualify for posting on the Exchange. That prohibition appears to have been relaxed.

These are significant procedural changes and they clearly increase the level of risk borne by Buyers on the Exchange.

I think it is clear that the changes have been made to allow TRE to attract more Sellers.

It might seem counter-intuitive that relaxation of procedural safeguards has been necessary to attract Sellers in the economic environment of the Exchange’s first year. After all, the papers have been full of stories about how difficult it is for businesses to find financing. But I don’t think the message is ambiguous.

TRE needs to ramp up volume to reach a level that makes it economically viable and proves to its equity investors that it is a viable operating entity for the long haul.

If the problem were attracting Buyers, any procedural changes affecting Sellers would be in the direction of tightening standards and procedures; making the risk profile more attractive to Buyers.

Changes in standards and procedures that increase risk to Buyers seem clearly to signal that the imbalance is on the Seller side.

The TRE calculus seems to be (this is my speculation only) that the Buyers will tolerate the increased risk as long as the risk is “potential” rather than “experienced”. That is, there are no significant Seller defaults and subsequent losses to Buyers. The implicit hope is that the Exchange can somehow control matters in the short term, avoiding any serious risk-related problems until it reaches its equilibrium level of volume.

At that time, maybe the process of moving back toward a level playing field can begin. If that IS what’s going on it’s a delicate and potentially perilous process.

On the positive side, while TRE will not hit its publically-stated volume targets this year, the volume HAS been ramping up significantly over the past few months and if we were to annualize current levels, the Exchange would come close to its volume goals on a run-rate basis.

If TRE can make meaningful progress on some of the impressive and important Seller-attraction initiatives already in place; including alliances with The Ariba Network, The American Staffing Association and Smyth Solutions, it is possible that it can reach a volume level in 2010 that can sustain its operations.

As it is approaching that critical volume level, however, it’s going to need some luck. The single greatest risk that it faces, I believe, is a nasty default and a public squabble over losses.

The additional risk in the system is real and “half a bubble” of tilt toward Seller-leniency is probably all the system can tolerate. Ultimately things will have to move back toward balance.

In the meantime: see my posts entitled “Caveat Emptor”.

Monday, November 23, 2009

Happy Anniversary!

The first auction of invoices on The Receivables Exchange closed on November 24, 2008.

The Exchange has gotten its share of “bashing” in the industry and, to be fair, it has earned some of that bashing.

But it has also earned, and not always received, clear and unambiguous recognition of the daring, and I think ultimately disruptive, innovation it has created in the receivables-finance industry.

The people who conceived of TRE didn’t come from the factoring industry. Maybe that’s why they COULD conceive of it: they didn’t know the sixteen reasons it could never work!

The Exchange has not yet proven itself to be a survivor. Adoption has been slower among both Sellers and Buyers than I am sure the founders had hoped. Quite a few early-stage assumptions and decisions have had to be jettisoned or modified. And that process is not yet over.

From my point of view, the Exchange has tilted significantly toward the Seller community as it has attempted to bring on sufficient product to meet its volume targets. And I’m not even close to being finished with the points that I’ve been addressing in my last two blogs on the subject of risks to the Buyers. Nor am I finished with offering my own views on structural and procedural changes I think TRE should pursue.

But I think we all should take just a day off from fault-finding and congratulate all of those who have worked so hard to turn a tremendous idea into a functioning reality.

All beginnings are hard.

Happy anniversary to all at TRE!

Sunday, November 15, 2009

Caveat Emptor # 2

In our post of June 20: “Blanket Security vs a Security Blanket” we discussed the fact that a Buyer of invoices on The Receivables Exchange obtains, via TRE, a lien on the receivables purchased and on any excess cash that might be available in the Seller’s lock-box account.

This is in contrast to the blanket lien on all of a Seller’s receivables that is often acquired as security by a factor or invoice purchaser; or, short of that, to the lien on all receivables due from one or more named Account Debtors.

The actual collateral providing security to a TRE Buyer is minimal relative to the industry norm.

The TRE Seller does provide an unconditional guaranty to repurchase a receivable sold on the Exchange if payment is not made to the Buyer by a date certain, which provides additional security to the Buyer. But that security is only as good as the Seller’s ability to perform.

So the importance of an accurate assessment of the Seller’s financial capacity actually increases in the context of a TRE transaction; because the specific collateral provided is more narrowly defined.

We’ve noted that the Exchange requires certain financial information to be provided by the Seller and that the TRE trading platform makes access to that information convenient. The Exchange itself, however, takes no responsibility for the accuracy or adequacy of the information provided and makes it clear that Buyers are responsible for their own due diligence and decisions.

As I’ve said before---that's fair enough, as long as we know the rules.

Those who have been in the business of buying receivables for any period of time will probably have had experience with transactions “gone bad”. Most would agree that more can be learned from one bad deal than from dozens of deals with which there have been no problems.

One of the things that I’ve learned is the importance of knowing whether I’ve really got a good, clear lien on an asset, and who else might pop up to make a claim on assets if things go bad for the debtor.

Not long ago an auction was posted on TRE by a first-time Seller. Besides financial statements, TRE makes available on its Seller Profile pages, a record of a UCC lien search. This tells us what claims have been recorded against the assets of the company and so has direct bearing on the strength of a Buyer’s collateral position.

In the case of this Seller, the prior UCC filings ran to 78 pages!

Now that, in itself, doesn’t mean that the position of the Buyer in the specific receivable being posted for sale is jeopardized.

It DOES mean, however, that the Buyer CANNOT know that its position is NOT jeopardized without devoting some significant time and attention to analyzing the prior filings. This is especially true because, in this case, there was no separate release of lien or subordination document provided for Buyer review.

A Buyer might have thought: “well let’s see if the financials are really strong and maybe I can take a chance making a bid even before I have the time to analyze the UCC filings”.

In this case it happened that the Seller’s most recent financials were noted as “internally prepared for use by management”. OK, that’s not really unusual, especially for interim accounting periods.

But in this case it happens that there is a single, large, intangible asset on the balance sheet that is roughly double the size of the company’s net worth. So, without that intangible asset, the net worth of the company would be negative rather than positive.

What’s my point?

I am NOT saying that this Seller shouldn’t be selling receivables on TRE.

I am NOT saying that TRE has failed in any way to provide what it has committed to provide to Buyers.

I AM saying, however, that TRE has made it clear that it is the BUYER’S responsibility to analyze the potential transaction and determine whether it has enough information to bid.

TRE has said “Caveat Emptor!”

I am willing to bet that in the period of time between the posting of the first auction by this new Seller and the time the first bid was recorded, no Buyer would have had time to analyze the 78 pages of UCC filings provided and determine whether or not the collateral provided was likely impaired by prior claims.

I am relatively sure that TRE will do all it can at this point in its life to try to work out any problems that arise with transactions on its platform.

But when TRE says, as it clearly does, that the Buyers and not TRE are responsible; it just makes sense to believe them.

The Buyer's first recourse is to the Seller, no matter who the Account Debtor might be and no matter what TRE might be willing to do to help out at this point.

So, indeed, let the Buyer beware!

Thursday, November 12, 2009

Caveat Emptor #1

In our post of November 3 we urged The Receivables Exchange to adhere to its policy of requiring quarterly updated financial statements from TRE Sellers and posting those statements to the TRE Platform.

In early posts on this blog (see particularly those in June and July) we made the point that TRE, itself, takes no responsibility for the accuracy or adequacy of the information provided to Buyers. It is the Buyer’s responsibility to perform whatever due diligence it considers appropriate.

Caveat Emptor: “Let the Buyer Beware”; is the position taken in the TRE documents.

Fair enough--as long as we know the rules.

On the other hand, while I stand by my compliment to the TRE Seller-sales staff in our last post. And, while I understand that bringing more product to the market is a critical TRE objective at this point. It is also in the long-run best interests of the Exchange to balance its attention between the interests of the Seller community and those of the Buyers.

Providing updated financials would be one way to illustrate that balance. The basic point I made on November 3 was that it is important to Buyers to track changes in the financial condition of Sellers after their initial qualification.

I had a reminder of that this morning.

One of my disciplines as a Buyer is to get third-party credit information on all Sellers that make it through my initial analytic filters. Some providers of credit information send out “alerts” to those who purchase information, communicating subsequent changes.

I received such an alert this morning on a company that is a TRE Seller.

This company has completed a number of transactions on TRE since the spring, apparently without problem. The financial statements made available at the time of its first transaction were as of April 30. No updates have been provided.

As a Buyer, I would hope that the Seller’s use of TRE would have allowed it to better its financial position over the course of its experience with the Exchange. But I got an alert this morning that it’s rating for “risk of late payment” has deteriorated and that a state tax lien had been filed against it.

Now, neither of these alerts constitutes a “life threatening” event. But both convey information that is important to me.

If an auction by that Seller is posted today I will have to approach it more cautiously than I would have last week. Until I can see updated financial statements I will have to assume that they would be weaker than those I have in hand.

That might be fair, or it might not. But that’s the position that “caveat emptor” requires.

Friday, November 6, 2009

It's a Page Turner!

There are some things that just shouldn’t pass without comment.

When I arrive at the office each morning I print and record the details of all auctions completed on The Receivables Exchange on the previous day. And I print and log the listing of all auctions that are “live” at the beginning of the new day.

Volume on TRE has been increasing significantly in recent months and the trajectory seems to be steepening as we move into fall. That’s a very good thing.

The Exchange’s Seller-marketing team has clearly been working hard.

But today, for me, was something of a milestone in TRE history. One that I think should be noted,

This morning, for the first time, the list of “live” auctions took more than one page to print!

Maybe I’m easy to impress; but I thought that was very cool!

Congratulations, guys!

Tuesday, November 3, 2009

Let's See the Numbers!

Companies that sell their invoices on The Receivables Exchange are required to provide two years of financial statements as a part of the Seller qualification process. Once approved as Sellers they are also supposed to provide quarterly updates to their financials.

Those updated financials are supposed to be posted to the Seller Profile pages, allowing Buyers to update their due diligence analysis.

As we approach the anniversary of the first TRE transaction I think it is appropriate to point out that the Exchange does not appear to be enforcing the requirement to update financial statements.

If it IS enforcing the requirement, it is NOT posting the updates to the Seller Profile pages.

The most recent financial information available, in many cases, is still as of year-end 2008. In nearly every case, the statements provided at the time a Seller posted its first auction are still the only ones available.

Given that the great majority of Sellers provide only internally-generated statements, it can hardly be argued that there hasn’t been time to update statements through at least the second calendar quarter.

As important as I think it is to Buyers to be able to make decisions on the basis of appropriately current information, the Exchange itself should also be looking closely at the changes in Sellers’ financials.

TRE has a significant stake in the impact of Seller use of the Exchange on Seller financial health.

I would hope, in fact, that the management of the Exchange has already made an arrangement with a credible third-party; perhaps a well-known business school, for instance; to study the impact of TRE’s unique platform on the subsequent financial health of its Sellers.

The job of attracting good-quality Sellers has been difficult. TRE does a good job of quantifying the theoretical value of accelerating cash receipts in its marketing efforts. If the theory is borne out we should be approaching the time when some ACTUAL value-added can be empirically demonstrated.

It would be a shame if the experience of the first TRE Sellers was not used to make the job of attracting subsequent Sellers easier.

Ultimately, proof of the value of TRE to its Sellers should be apparent in the analysis of subsequent financial results. If subsequent statements are not obtained by TRE and made available for analysis, not only will TRE Buyers be inappropriately under-informed, but a key analytical and marketing tool will be lost to TRE management and marketers.

The transparency of the auction process should be matched by transparency in the information flow.

So, let's see the numbers!