A VC in Vacationland

2 responses to “Managing Your Start-up: Receivables Exchange”

1. 

   jonathan

   February 5, 2011

   http://westlawnews.thomson.com/NationalLit/SearchResults.aspx?folder_id=0&search_text=receivables+exchange
   The Receivables Exchange doesn’t seem to be what it markets itself to be! It is a little scary. It seems that without some form of insurance, or guaranty from the Exchange (only as valuable as the Receivables Exchange’s balance sheet) as to the validity of the invoices auctioned over the Receivables Exchange, the model can’t work in Actuality – as good as it sounds in theory.
   I guess the bottom line is that what the Receivables Exchange actually does it make it really easy for bad people to steal. Think about it . . . post invoices, no one is allowed to talk to your customers (except the Exchange, and they neither have the experience nor motivation, as they are a start up, have no archival credit knowledge and assume no responsability Buyer losses), buyers desperate for yield assume everything is Kosher (look at all the wonderful press they have gotten from prestigious publications) and bid against one another to buy the invoices, driving down the price and up the funds available . . . the Sellers just post, receive funds and then disappear! It is actually genius, if your business is fraud.
   I suppose the problem is that most of the Buyer (certainly those listed in the complaints I discovered) are not big sophisticated institutional investors, as the Receivables Exchange represents on their site. Rather, they are individuals looking to earn better yields than are available elsewhere, and are looking to “this new and risk adjusted asset class” as a their solution!
   Buyer beware never was more appropriate.
   It seems to me that unless the Receivables Exchange institutes all the safe guards commonly implemented by factors and asset based lenders (verifications, notified collections, audits, etc.) they will essentially be providing financing to companies otherwise unable to access conventional financing sources (banks), without any of the safeguards. Ultimately, this will prove fantastic for sellers and bad for buyers. Not a win win, and thus not sustainable.
   Four other obvious flaws, and I only realized this when in my due diligence activities I got past the marketing materials and looked at the Receivables Exchange’s actual agreements:
   1. The Exchange requires all Buyers to assign to the Exchange the responsibility for all due diligence activities (perfection of security
   interests, seller analysis, verification, etc.) and yet also disclaims all responsibility in the event Buyers are unable to collect purchased invoices (you can see this in the agreements attached to the complaints. Where else have we seen this model fail? Mortgage crises anyone). How does that make sense from a Buyer’s perspective? The Receivables Exchange handles all the due diligence activities but is in no way responsible for the effectiveness of those activities, and expressly waives all responsibility. Where else in life would anyone accept such a proposition? I understand why the Exchange needs to handle things this way (Sellers don’t want multiple Buyers contacting their company, or worse, their customers, so the Exchange sells that it is the sole point of contact), but it simply isn’t sustainable.
   2. Even if it made sense to assign responsibility for safeguarding the validity of the invoices available for auction to the Exchange, if it ever achieves scale, how is it actually going to execute? They would need to have a massive internal risk management group to handle Billions, if not Trillions of dollars in invoice purchases, especially from an audience of small firms otherwise unbankable . . . I think they have approximately 100 employees, almost all in sales. CIT handles $40B a year in volume, from Sellers that are predominately bankable, and has a risk management staff in the thousands. BB&T, handling more than $9B in volume has more than 300 in risk management and one person in sales. Finance companies’ staff loads must be weighted toward risk, not sales.
   3. You simply can’t provide financing without implementing all of the necessary steps to ensure the safety of the funds you put out the door. The Exchange may say, “We handled more than $200,000,000 in auctions in 2010, and Buyers only lost $9.5MM” Even if the net loss is less, let’s assume $3MM on $9MM in fraudulent invoices (and this assumes there were no frauds other than these two cases, which is doubtful), if the average fee earned by Buyers is 1.5%, on $200,000,000 in auctions, gross revenue for the Buyers is
   $3MM, which is to say that if one buyer purchased all auctions, the net effect would be a return of 0%, if the frauds were limited to $3MM. Of course, some buyers collected the invoices they purchased, and some didn’t (just like in Madoff, some achieved returns and some didn’t, until the music stopped). The Buyers of the fraudulent invoices lost everything, their return and their capital. Again, not a sustainable proposition.
   4. Possibly more important than anything else the Buyers are all unsecured creditors of the Exchange and have no actual right to collect the invoices they are purportedly buying. Here is what I was told. Theoretically, the Buyer buys the invoices and “owns” it. However, the collection responsibility is assigned to the Exchange, the Exchange files the security interest on the account (s) of the Seller and the Exchange receives the payments from the Seller’s customers. When payments are received by the Exchange, into their checking account, a liability is created from the Exchange to the original Buyer, and in a perfect world, the Exchange transfers the funds from their account to the buyer’s account within one day. However, and this is worst case, mind you, what happens if the Exchange fails, or has liabilities in excess of its assets? Worse, what happens if the Exchange, itself, enters into a secured lending relationship with a bank or finance company? All of the funds in its checking account would become collateral for its lender. In a bankruptcy, the Buyers would simply be unsecured creditors of the Exchange making claims to collect an unsecured debt (the moneys the Exchange received into its commingled account). In this scenario the Buyers wouldn’t even be able to directly pursue the Seller’s customers for payment . . . chaos indeed.

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2. 

   Dave Anderson

   February 17, 2011

   Jonathan
   I appreciate the heads up….need to look into these guys a bit more.
   Dave

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