An Inconvenient Essential--Part Two

In our last post we identified the invoice verification process as a potential source of “friction” in TRE operations; potentially a threat to both its speed of growth and even to its scale.

We discussed the steps taken by TRE to mitigate the friction and concluded that there appears to be a reasonable balance between: a) the risks posed by forgoing certain typical verification requirements, and b) the risk-mitigation elements in the TRE process.

But the issue cannot be left there. The fact that there are procedural protections that mitigate the apparent risk does not address the question raised by the fact that TRE, itself, verifies the receivables proposed for sale.

Given TRE’s rapid growth goal and the potential for the verification process to impede that growth, there is a potential conflict of interest that has to be acknowledged.

According to the materials available on the TRE website, it was initially expected that the verification process would be outsourced. The idea that a reputable third-party would be handling the verification process was expected, I assume, to give Buyers comfort that there was no potential conflict.

In fact, however, the process in place does not include an independent verification agent.

I do not know what caused the change in direction so my comments here have to be understood as no more than my own speculation.

If I were going to identify a list of candidates for the job of verification agent I would probably start with the big accounting firms: well-known, respected and knowledgeable; the names you find on public companies’ audit reports. They also employ hordes of relatively inexpensive, entry-level professionals.

The second group that I’d reach out to would be the credit rating firms with high name recognition i.e. D&B, Experian, Equifax, etc. These firms also employ large numbers of relatively inexpensive information gatherers.

From the perspective of an accounts payable person in a Debtor’s office it would probably not seem unusual to get a request to verify information from either a well known accounting firm or from a credit reporting agency.

From there, though, I begin to scratch my head. I’m not sure what other type of firm would have the capacity, the name-recognition, the staff resources and a willingness to consider the job, at a pricing level that would make sense.

If a well-established accounting firm or credit reporting agency were to consider the assignment, what would be the likely outcome? My guess is that they would quickly get tied-up in problems of definition, procedure, authority, work product and potential liability.

What level of authority must the individual providing verification possess? How is that authority ascertained? What reason can the verification agent give for wanting the information? After all, the Debtor isn’t told the invoice has been sold. What is the minimum evidence of acceptable confirmation? What specific assertions are required? How does the verification agent assure TRE that it has actually obtained the information if it is obtained only orally? Would it be feasible to obtain any written verification and, if so, at what cost in terms of transaction speed? What level of liability, if any, would the verification agent assume for the accuracy of its information? If no liability is assumed, what is the quality-control leverage?

You get the point!

The IDEA of an independent verification agent is unquestionably an appropriate one. The difficulties in implementing the idea are just as obvious.

The question now becomes: given that there IS an apparent potential for conflict, how real is the likely risk to a buyer?

In order for TRE to grow as it wants to grow, it needs more than anything else to establish credibility early. Better to lose potential business through excessive caution than to subject Buyers to losses through lax underwriting.

There is also meaningful value to TRE, I suspect, in doing the job itself (at least for a time), since the experience it gains will help it better fashion an effective relationship with a third-party should it attempt that in the future.

My own view is that, while the potential for conflict is obvious, the current risk is minimal. The stakes for TRE are too high at this point to jeopardize its long term goal by taking shortcuts this early in its development.

However, as the exchange ages a bit and the time approaches to actually meet the growth goals on which its establishment and financing were based, the level of risk could well rise.

As one who wishes success to the TRE enterprise, I hope that its management plans to ultimately establish the independent verification process that was apparently contemplated in its initial conception of the exchange.

"You've Got Bank!"

Have you heard the ads that some banks are running on the radio these days? How your banker really, really understands you and is on your side, working nights and week-ends to make sure you get great service?

Please……….

If you have a small business, or even a pretty good-size business, going to your bank for financing is as pleasant as a root canal…and the odds of success these days are much lower.

The Receivables Exchange provides a truly unique alternative to traditional financing. It is not a borrowing. It is a sale of an asset. You are converting one asset…money due to you from a customer…to another asset…cash.

A Seller on TRE can choose which of its receivables it wants to sell, when it wants to sell them and how much it wants to pay for the ability to convert the bulk of that receivable into cash.

Of course, the Seller has to meet certain qualifications. The companies that actually owe the money have to agree to re-direct payment to the TRE lock-box. And there has to be a Buyer willing to bid on the receivable you want to sell.

But the qualification process appears to be reasonable and timely. I’ve already written about the benefits of the lock-box arrangement. And I understand that over 99% of the listed auctions are ultimately funded. That doesn’t mean the Seller got the terms requested; but the terms were apparently acceptable…because an agreement was ultimately reached.

The truly dazzling feature of the process is the speed. I have seen TRE transactions disappear from the auction list in, literally, a matter of seconds!

Imagine… as the owner or the CFO of a TRE Seller you determine you need some cash. You select a receivable due from a pre-qualified customer. You post the receivable for sale on TRE, specifying the pricing you’d like to obtain. Your desire gets communicated to all TRE Buyers, who are then able to bid on your receivable. When a Buyer makes a bid, you see it immediately and, at your option, you can accept it or wait for a better offer. When you do accept an offer the auction is closed and both parties are notified of the agreed-upon terms.

Now, I’m a Buyer, not a Seller, so I don’t actually know what message the Seller gets when an auction closes. But in effect the message is….

“You’ve got Bank!”

You’ve requested financing and gotten a commitment for essentially immediate funding, on terms that will not be changed by someone higher up the chain. And you’ve done it without ever having to talk to a banker.

How cool is that?

TheTRE Value Proposition #3: The "True Sale" Issue

Trivia Question: What is the only State in the US whose civil law code is NOT based on English Common Law?

Answer: Louisiana.

One of the incorrect bits of trivia often attributed to Louisiana is that its civil law system is based on the Napoleonic Code. That, I’m told, is not actually true. It is true, though, (for you trivia lovers) that the first version of the Louisiana code was written in French.

I am not a lawyer but if you have spent any time in the financing business, especially working on problem situations, you do tend to become quite sensitive to legal “technicalities”.

Consider the following scenario: A business is owed money by a customer. It sells the right to receive that payment to a 3rd party. The seller unconditionally agrees to re-purchase the receivable from the buyer if the buyer is not paid by a stated date.

Question: Is this transaction truly a sale of the receivable or is it really a financing? Does the absolute commitment to repurchase give the transaction the character of a loan more than a purchase?

Answer: It depends on the law that governs the transaction.

Question: Where does the governing law hold that such a transaction is unquestionably a sale of the receivable and not a financing transaction?

Answer: Louisiana.

The Receivables Exchange is based in Louisiana and Buyers and Sellers of receivables traded on TRE agree to accept Louisiana law as the controlling law for disputes.

Louisiana has adopted the Uniform Commercial Code, which attempts to standardize business law across the country. But Louisiana modified a critical section of the UCC that deals with buying and selling of receivables. The modification is critical.

In Louisiana the scenario outlined above, of a sale with an unconditional re-purchase agreement, is by law a “True Sale”. That is: it will not be considered a financing regardless of the re-purchase commitment.

Why is that of critical importance? Because it takes disputes out of the realm of the laws related to loans or financings; including questions of usury, for example; and contains those disputes within the realm of laws relating to the purchase and sale of assets.

There is tremendous advantage to the clarity of position that this brings to those, especially the Buyers, who trade on TRE.

Knowing that a broad range of potentially difficult and costly legal disputes can be avoided because of the Louisiana “True Sale” language, removes an element of risk from the process of trading on TRE.

And reduction of risk has value!