Invoice trading is also known as p2p invoice finance or invoice crowdlending and is a type of peer-to-peer lending that allows individuals or institutional investors to purchase invoices or receivable notes from a business at a discount. It is characterized by being asset-backed lending in which the invoice function as collateral. The collateral value of an invoice is the future payment of purchased goods by a company or government.
Invoice trading requires three parties: A network of investors, an online p2p platform, and a company willing to sell an invoice or receivable note at a discount. For some companies, invoice trading is attractive because it will free up cash from, for example, slow paying customers with payment terms above 60 days; investors will be looking for attractive returns; and the p2p platform will earn their money by charging a fee to either the business (typically an SME), the investor, or both.
Invoice Trading as a Source of Finance for SMEs
Businesses usually engage with invoice trading if they are looking to improve their working capital and free up cash that can be used to improve their short-term liquidity, pay expenses, or make new investments to grow their operations. This situation happens because many companies sell their goods or services on credit – especially to larger customers, which means that they will not receive payment until a later specified time in the future. An example of this could be snow removal companies working in two specific winter months using expensive equipment but get paid only after 90 days, or some other specified period. Thus, by using its unpaid invoices or receivable notes as collateral, a business can sell its accounts receivable and solve potential difficulties related to a range of issues, such as the beforementioned long payment period, obtaining business credit, cash flow, and short-term liquidity for unexpected expenses. Also, it enables the business to reinvest in growth earlier than what would otherwise have been possible if they have had to wait to receive payment later.
Outstanding invoices can be financed in two ways. The invoice can either be sold for instant payment to release cash and improve the working capital of the company immediately, or it can be sold via a more complex structure to secure a revolving line of credit. The main alternative to invoice trading, traditional invoice factoring, provides many of the same advantages as invoice trading, but with less flexibility and speed. Also, due to the digital nature of invoice trading or p2p invoice finance, it is likely to provide a more user-friendly experience for the business.
Invoice Trading as an Investment for P2P Investors
In contrast to other types of peer-to-peer lending, like p2p business lending or p2p consumer lending, where the investment is often unsecured, invoice trading has the advantage of having the invoice as collateral. However, there is always the risk that the customer will never pay the invoice, which would potentially result in an expensive and complicated process – depending on the structure of payment terms, the company that owes the money specified on the invoice, and the p2p platform.
As an investor, you will limit your risk when not lending the total amount of the invoice amount to the company borrowing as this creates a strong incentive for the borrowing company to collect the total amount owed on the invoice, or you will be more investors interesting in collecting the owed collateral.
As an investor, you can diversify your risk on the p2p invoice market by not buying the full amount of the invoices you invest in (the amounts are often quite large as it would otherwise not make sense to sell them on the invoice trading markets), but instead buy a small piece of many different invoices. This will also ensure that many entities have an interest in the invoice being paid according to the terms, both all the other investors but also the p2p platform who is interested in showing good returns. If you want to know more about how to diversify your risk, you might find this guide to diversification in p2p lending interesting.
Invoice Trading Around the World
So far, invoice trading is especially an important type of alternative finance in Europe, where it is ranked as the crowdfunding model raising the second highest volumes, according to the newest data available on the European crowdfunding market. Thus, in 2017, €535.84m was raised through invoice trading, which corresponds to 15.9% of the total market of €3.4 billion. At the same time, invoice trading has experienced impressive growth rates with average annual growth between 2014-2017 on 480.2%.
Looking at the Americas region, invoice trading is a much small market in terms of market share accounting for only 0.6% of the overall market. However, it is important to keep in mind that the American market for crowdfunding with a total volume of $44.3 billion is much bigger than the European market. This means that $270m was raised through invoice trading in the Americas region in 2017.