Monday, February 1, 2010

To Discriminate: v. di-skrim-uh-neyt

The Bain announcement is now old news. It’s still good news...very good news, in fact.

But a new day and month are upon us.

The problem of FUNDING continued growth and development of The Receivables Exchange has been solved for the time being.

Now there are other problems to solve.

I heard it said last week that perhaps Bain could help to bring in new Buyers. And that might well be so. But if that is their principle follow-on benefit, the TRE proposition might still fail.

The TRE challenge is not availability of Buyer funds. Any one of a number of current Buyers could probably absorb the entire current deal flow without any great problem.

On the Buyer side the best possible solution would be for a steady addition of Buyers who commit NOT to flood the market with liquidity, but rather to limit their activity to provide a balance between supply of and demand for funds.

The challenge for TRE, without any doubt, is attracting qualified Sellers.

A friend who knows her way around QuickBooks told me the other day that she had been asked by a relative to help him organize the financial data of his business. The business has been in operation for quite some time. Until the current downturn in its industry it had grossed nearly $20 million per year. And it is of a type that might qualify for Seller-membership in TRE.

She told me that she found that her relative had no real idea of the financial condition of the business; that he could not even tell her how much cash was in the bank; that essentially all of his family’s personal expenses had been run through the company, making analysis of the profitability of the business itself very difficult; and, that the only real “control” mechanism exercised was at the level of pricing bids for new work.

This might be a good business; it probably is; but no one can really tell because of the way that it’s being managed. And I would bet that there are hundreds and thousands of businesses all over the country that fit this same description. Over time, with some outside help and some discipline, this business owner might be able to change his practices and create a financial track-record that would support an application to sell invoices on the Exchange. But that won’t happen in one year.

Penetrating this segment of the potential TRE Seller market is a long-term project. But TRE needs to ramp volume in a serious way in the short-term. How might it do that?

Remember when “to discriminate” simply meant “to distinguish by discerning or exposing differences; especially: to distinguish from another like object”?

I've argued in more than one prior post for the establishment of a quality rating system to distinguish among Sellers so that Buyers might be better able to support risk analysis and pricing differences. That idea, like the education of the class of business owners discussed above, is a longer-term project.

But there is a variation on that idea that would NOT take substantial time.

There is a class of business that finances its receivables through factoring companies or divisions that require audited financial statements. The rates that these companies have come to expect are at the lowest-end of the range that TRE Sellers currently command.

Those companies have not become TRE Sellers and the financing firms that currently serve them have not become TRE Buyers.

But these are the big fish on both sides of the transaction equation!

There is no question that TRE needs to continue to work very hard on expanding its book of smaller, higher-rate-paying Sellers. But in the near term it also needs to go after some of the bigger fish.

What’s the bait for that enterprise?

Why not create a separate class, or designation, of Seller? Why not discriminate? Not in function; just in terms of designation.

Given that the guarantee of the TRE Seller to re-purchase invoices not paid by Account Debtors is the principle security of a TRE Buyer (whether recognized or not). And given that almost no current Seller financial statements are actually audited. Why not create a class of Seller distinguished simply by their ability to provide audited financial statements? And add some sort of designation to the description of that Seller to distinguish it from the others. Or collect the auctions of those Sellers on separate "page". get the idea.

This would assure the potential Sellers that they will be presented to the Buyer community in a way that recognizes that they are qualitatively distinguished from companies like that of my friend’s relative; presenting greater assurance and, therefore, less risk.

This would allow potential Buyers whose internal controls require audited financials to at least consider TRE membership.

This would provide a simple, logical and supportable means of differential risk assessment and transaction pricing.

And, it could be implemented immediately and without cost.

It is, at best, a proxy for a real system of quality discrimination.

But even a proxy has value!

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