Sunday, February 21, 2010

Selling the Counter-intuitive

In my traditional invoice-purchase business, one of the most difficult points to make to a new seller is that their interests are NOT best served by trying to sell the invoices of their WORST paying customers.

It is most often the case that they are best served by offering for sale the invoices of their most RELIABLE customers. In this case I look at reliability in terms of both credit strength and predictability of payment.

The first impulse of the seller is often to try to find a buyer for their problematic invoices; on the theory that they then become the buyer’s problem. But because we require both personal guaranties and first liens on all receivables, that logic is flawed. In fact, an Account Debtor that is predictably problematic might well become even more so when they become aware that their obligations have been sold.

Most often the best solution is for the seller to offer for sale the invoices that present the LEAST UNCERTAINTY to the buyer. That doesn’t mean that they’ll necessarily be paid the quickest; there are a lot of very good customers that pay reliably in 45 or 50 or even 60 days.

But a customer with good credit that pays reliably in 50 days might be a much better solution to the seller’s cash needs than either: 1) a customer that pays reliably in ten days, or 2) one whose credit history is either poor or whose payment timing is erratic.

The customer that pays very quickly is probably not the source of the seller’s cash flow need in any event; and the buyer then faces the need to rapidly re-deploy the funds returned, having earned a relatively small fee for its efforts.

On the other hand, the reliable customer whose obligations are outstanding for a reasonable and predictable period presents not only a lower overall risk profile but also requires lower re-investment velocity and the likelihood of maintaining a higher percentage of funds employed.

Over time, that sort of Account Debtor should command the lowest fees from the buyers and provide the sellers with the least expensive solution to their cash needs.

In the specific case of The Receivables Exchange, this issue of least uncertainty is even more important.

Because the Buyers on TRE do not have the protection of personal guaranties or first liens on all receivables; and the TRE notification and verification processes are not as strong as is usually the case in single invoice purchases; there is limited scope for managing transaction risk.

Essentially, the TRE formula presents the Buyer a “barbell” shaped risk analysis problem.

The Buyer can make a decision regarding the Seller and one regarding the Account Debtor. But some important elements that constitute the relationship between the two are unavailable to, and not under the control of, the TRE Buyer.

As we’ve written a number of times before, the TRE Seller-marketing team has an inherent incentive to “reach” deeply into the pool of possible Sellers to ramp up volume. And we’ve seen some Sellers that clearly appear to have questionable financial capacity.

Often transactions involving Sellers of questionable financial capacity, even Sellers that have not yet completed a single TRE round-trip transaction, are priced quite favorably by TRE Buyers. And the reason for that is usually quite clear: the other end of the barbell, the Seller, is a well-known and established firm.

The current statistics on the TRE website show that 81% of the Account Debtors whose invoices are offered for sale on the Exchange are “Investment Grade”. Debtors whose stock is publicly traded represent 58% of the transactions. And those whose stock is among the S&P 500 represent 50% of the transactions.

While the strength of the Account Debtor might make little ACTUAL difference in many conceivable instances in which a transaction might become problematic, it is certain that a strong Debtor reduces at least the APPARENT risk in a transaction.

I have heard the TRE Seller-marketing argument on this point. They stress quite effectively the point that Sellers are best served by offering the invoices of their BEST customers for sale. Offering the least apparent risk attracts the broadest interest, the best pricing and ultimately the lowest-cost solution to the Seller’s cash flow problem.

A Seller with marginal credit credentials can get a lot of attention by offering the invoices of an S&P 500 Debtor, even though it is ultimately the Seller’s financial capacity that the Buyer must depend upon.

The statistics above make it clear that the TRE Seller-marketing team is doing a very good job at convincing Sellers to offer the most attractive invoices they have, rather than trying to unload their problems. Such an attempt would ultimately fail in any event, damaging both the reputations of the Exchange and the Seller.

The argument is still, at least initially, counter-intuitive. It’s not an easy sell. And TRE should be complimented for making it well and successfully.

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