Boost margins and reach: captive factoring companies
Most companies are handing away some of their margin to the market because they take unfunded trade credit from their suppliers. This leads suppliers to use credit insurance, to factor their invoices and to take other kinds funding in their local markets.
The amount of unsecured funding provided to suppliers by relationship banks can be larger than the credit limit provided directly to the company itself. The corporate treasurer of one of our clients found this to be the case recently.
This is lost margin - why not provide that service to suppliers yourself?
There can be no impact on your credit lines if you are simply bringing in-house the credit capacity that is currently being provided externally.
And you are gaining more visibility and control over your suppliers, and capturing the margin on that supplier financing into your own P&L - especially because a captive factoring company can reach into the long tail of your supply chains.
Captive factoring companies - easy to set up, much more flexible than SCF
A captive factoring company is the solution - see an explanatory article on the topic here.
Captive factoring companies - not a new idea
There are more of these kinds of "companies" active in the market than you might imagine. These structures have been common since the 1990s, although usually only in larger businesses. As this article explains, the technology is becoming simpler and easier - and available even to mid-sized companies now.
There are two generic models that we have seen, explained further below:
Sourcing and payments platforms (operationally-intensive with the processes integrated into the buyer's sourcing model).
Captive factoring companies (standalone and only involving suppliers and supplier payments).
For completeness, we can also mention that there are "receivables-side" captive factoring companies that factor receivables due to the company from its customers ("securitisations"). These are complex to set up - and not in the scope of this article - other than to note that the payables-side captive factoring company can deliver similar outcomes but much more simply.
Sourcing and payments platforms
Many large multi-national companies have set up a sourcing and payments platform (a subsidiary and a team), typically basing them in a low tax jurisdiction.
Purchase orders are made in the ordinary way by the business, but goods are sold by suppliers to the sourcing platform, and
Payments will be made to suppliers from that platform
There is then a subsequent internal sale of goods to the operating business that follows, often at a higher price
Suppliers hand over their goods or provide their services directly to the operating business units but the supplier then invoices and gets paid by the sourcing platform. Taking care of transfer pricing rules, goods are re-sold from the sourcing platform into the operating business units at higher prices, booking a surplus into the sourcing subsidiary.
This also allows the soucing subsidiary to control how and when suppliers are paid and to gain external finance.
This is a buyer-side and buyer-focussed operation.
These structures can be quite involved to set up and require a lot of planning because they are integrated into the buyer's operations in multiple countries and jurisdictions. But they deliver a lot of value, streamlining processes that otherwise are spread out and duplicated across operating units, as well as centralising revenue in one jurisdiction.
The sourcing and payment platform represents an important precedent when it comes to thinking about a captive factoring company. This is the granddaddy of the captive factoring company.
But the captive factoring company is much simpler and still delivers comparable benefits.
Captive factoring companies
The captive factoring company is simpler because it does not interact with the operating businesses, or require any changes to the way that orders are made and title to the goods moves. It can be implemented entirely on the "supplier-side" without encroaching on the way that operating companies conduct their business.
Moreover, the new breed of digital SCF platform means that captive factoring companies can be a lot more capable, whilst setting them up and operating them has become a lot easier.
This is a supplier-side and supplier-focussed operation.
A company is set up and appropriately licensed to carry out factoring activities.
In the UK, this only requires registration with the FCA (the regulator) which is means filling in a form and paying a small fee.
In some countries (eg: France, Germany, others) factoring is a regulated activity, so the process is more involved.
BUT, you can set up the company anywhere, in fact - so pick an easy jurisdiction.
The factoring company might be a subsidiary of the parent business or might be standalone - this is a detail. For the purposes of this article, we assume it is a subsidiary of the "parent business" - ie: the corporate buying group.
The captive factoring company can be financed both by the parent business and independently in the market in its own name. It borrows money in order to fund factoring services that it offers to suppliers to the parent business across all its operations and locations. Usually it would not offer services more widely in the market (ie: to others).
Suppliers provide trade credit terms on their invoices in the usual way (30/60/90 days etc). If a supplier would like financing, rather than go out into the market and pay high rates with credit insurance premia on top, it can take financing from the captive factoring company instead. The captive factoring company purchases the invoice upfront for cash from the supplier and collects the money from the parent business later.
This enables the market charge for factoring to be captured internally and monetised.
Captive factoring companies are also much more capable than supply chain finance programs:
That's because lenders to the captive factoring company do not need to on-board the suppliers, since the suppliers are not their customers.
It's also easy to mix in multiple funding sources without having to allocate individual suppliers to individual funders - there is much more flexiblity.
And it's very straightfoward to include the buyer's own surplus cash as a financing source, enabling the whole of the factoring margin to be captured.
Setting and running a captive factoring company
This might sound like a technical and daunting process, involving a lot of legal set up, regulatory risk and complexity.
It's simple to set up a captive factoring company.
Moreover, PrimaTrade provides a flexible and truly multi-funder platform that can run your captive factoring company and we also provide an out-sourcing service. We can deal with all these matters including setting up or providing the company, establishing the processes, managing compliance and providing all the relevant policy and procedure documents, and then we can run the daily operations - leaving you to decide on the strategic questions of:
Where to locate the company?
How to fund the captive factoring company (mix of internal and external)?
How much of the supply chain to on-board?
Noting that a captive factoring company can likely handle the whole supply chain including the long tail, and
not just larger suppliers like a supply chain finance program
How to price the services?
Noting that a captive factoring company should be highly profitable because:
the only material risk it runs is credit risk on the buyer (ie: the parent), and
revenues are driven by recovering the margin from the market that is currently being paid away on credit insurance and to external factoring companies.
What about accounting treatment?
Most companies want their captive factoring company to deliver an off-balance sheet outcome for the parent company accounts (ie: the factored invoices from suppliers in the captive factoring company continue to be shown as trade credit or current account payables).
Captive factoring companies can also be used as part of the active management of ROCE and balance sheet optics generally.
These results can be delivered. Call us to discuss how this can be achieved.
There are also other important matters which a captive factoring company can enable you to address:
CSDDD in the EU, or ESG regulations generally - which require companies to treat suppliers ethically and fairly. Typical SCF programs fail this test because the suppliers that really need liquidity support (SMEs in difficult jurisdictions) are usually not included.
So more transparent and internally-managed financing models are important initiatives which are aligned with these principles.
Are captive factoring companies quite common?
As mentioned above, there is a lot more of this going on than most treasurers and CFOs might imagine..
We can explain more - and show you case studies and examples of efficient structures that companies are using right now in these areas.
Moreover, digital SCF platforms like PrimaTrade have made it much cheaper and easier to set up and operate captive factoring companies, allowing set up, operations and compliance processes to be outsourced.
Give us a call to understand the benefits and process.