Editorial Board member of TRF News and CEO of HPD Software, Kevin Day speaks about the “growth factors” supporting asset-based finance (ABL) industry.
What do we mean by “growth factors”? We believe that there is untapped potential and the ABF industry needs to adapt and respond. We don’t have all of the answers but as an active member of the ABF community we’re happy to share our thoughts and be part of a positive debate.
Asset-Based Finance (ABF) is a competitive world where client loyalty is by no means guaranteed; businesses quite rightly shop around for the best deal. Although volumes increase year on year, the actual number of businesses using the product in mature markets seems somewhat stagnant. According to the FCI latest figures for the EU, the total number of clients is 208,000. This is not a dramatic shift from last year. In the UK, the biggest market for ABF according to the FCI figures, the number of businesses using this form of finance is actually shrinking.
So what is the addressable market for this financial product? There are no accurate statistics for this, as it depends on what we consider the ideal profile for a business suited to this type of finance. At the very least, the business would have to need finance; any business with cash deposits is a non-borrower – a non-starter for ABF! Then it comes down to why the business needs finance; short-term working capital needs or strategic, longer-term investments, acquisitions? We then move on to the risk profile of the business. ABF assumes that the underlying collateral, mainly outstanding invoices, is collectable. Therefore, businesses deemed to be unsuitable for ABF would be ones where the risk quality of the debtors is in doubt, where there is a strong likelihood of performance risk or where there is propensity to offset payments against monies owed to the client: Can’t pay, Won’t pay, Nothing to pay. For these reasons, sectors such as construction (high performance risk) or transportation (risk of offsets and contras) are often deemed to be “unfactorable”.
Of course, another major barrier to being “ABF Ready” is the financial standing of the business. Although the finance facility is underpinned by the collateral, the invoices, a business with a poor credit rating is more likely to get into financial difficulty, commit fraud or collapse completely, making it hard to collect the outstanding invoices, if they really exist at all!
For the moment, let us assume that in a mature market, the penetration into the addressable market is around 10%. The UK has around 40,000 businesses using ABF today, so that would put the addressable market at 400,000 businesses against a total business population of around 5 million. An untapped market of 360,000 businesses? What are all of these businesses currently using for their financing needs? If we just consider the competitor products to ABF, the most widely used product is the classic bank overdraft (line of credit). In second position is Asset finance/leasing which is significantly larger in terms of lending than ABF. We then have the new kids on the block, the Fintechs, such as peer-to-peer lending and invoice auctioning platforms; highly visible although low volumes to-date.
From a business perspective, if we compare ABF to these other financing solutions, they are all fairly simple to understand and easy to operate on a day-to-day basis. One of the accusations aimed at ABF is that it is overly complicated, contractually cumbersome, intrusive and costly; let alone some of the reputational concerns about lending of last resort. It does feel an uphill struggle at times!
For ABF to really grow and take advantage of its potential, it needs to increase the addressable market – that is, exclude less businesses – and be less complicated to compete with the other sources of financing. ABF also needs to be more “sticky” so that clients stay loyal to, at least the product, if not the provider. There is no magic wand for this and it is incumbent on all ABF providers to increase their own target markets and to focus on how they can grow their portfolios by winning new-to-ABF business rather than recycling existing users; be a hunter, not a poacher!
How can an ABF provider increase its target market? There are four main areas to consider. First of all there is the opportunity to support larger corporates. Solutions such as Asset Based Lending or receivables purchase programmes can unlock opportunity at the upper echelons of business. Supply Chain Finance can provide early settlement of invoices to suppliers of the corporate and floor planning/distributor finance can provide extended payment terms to the customers/resellers of the corporate; liquidity can be injected both up and down the supply chain, all leveraged off receivables as collateral.
At the other end of the scale, smaller businesses are difficult, especially for banks, due to the cost to serve versus the returns; just not profitable enough. The solution here is to use technology to take the cost out of the process. Automated on-boarding reduces the cost of acquisition. Digitalisation, such as pulling collateral data from the client’s accounting system (increasingly cloud based), reduces cost and streamlines the process.
Next we have the international dimension. Expand the portfolio by targeting exporting businesses and supporting them with value added services that help the business navigate international trade, foreign exchange handling and collecting overseas debt, possibly using a correspondent under the Factor’s Chain International association. Importing businesses can be assisted using purchase order finance and facilitating purchases, securely, from foreign entities.
Finally, it is possible to unlock market segments that were previously deemed unsuitable. Contractual debt, common in construction and the IT sector, can be managed such that the performance risk issues are mitigated. It takes expertise and an “eyes wide open” approach, but the returns can be significant. Niche solutions for professionals, recruitment agencies, body shop and medical care providers can offer opportunities for growth.
To make ABF attractive to business, it has to be relatively simple, cost effective and not onerous for the business to manage the facility. Fintechs have shown the art of the user experience – this is the benchmark that ABF providers must attain and surpass. It is not just about an easy to use website. Contracts must be short and sweet. Terminology must be in plain language.
But what about client retention – making ABF “sticky”? Here the ABF providers have a huge advantage because, by definition, they are at the heart of their client’s business. The ability to provide value-added services can transition a provider from being a “necessary evil” into a valued business partner. These services could range from out-sourcing basic components of business operations: invoicing, payroll, HR, collections, litigation, etc. Alternatively, to more consultative services such as data analytics, marketing, business advisory services, taxation, etc.
If all ABF providers focus on growing their target markets, by definition, the total addressable market will grow. Success breeds success and with the right approach across the sector, more and more businesses will see the virtues of ABF and how it enables business to grow. So, heads up ABF providers, walk tall and let us push back the frontiers of this brilliant financing solution.