18
May

HMRC cracks down on late payment

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Jeremy LawrenceNew HMRC figures show a dramatic increase in the Time To Pay (TTP) refusal rate, alongside a drop in demand and ongoing concerns about the way the service operates.

The percentage of TTP requests refused during the first quarter of 2011 was 9.3%, compared with 2009 and 2010 when the refusal rate was just 2.7% and 6% respectively.

HMRC have attributed this partly to changes in economic conditions and partly to the number of repeat applicants. Demand for TTP is at 40% of the level it was in 2009 and 61% of the level in 2010. The assumption is that reduced demand is down to reduced need. It is hard not to wonder whether the reduction may also be down to the general feeling that TTP will not be approved so why waste time?

HMRC told claims that the increase in the refusal rate is in part due to the high level of repeat requests. A spokesperson said: “Inevitably, if a business requires a second, third or fourth arrangement it is only right that we ensure that the requirement is purely temporary and not the result of a deeper problem”.

HMRC plays down any suggestion of any tightening of criteria, despite arguments to the contrary from within the accountancy community in recent months. Earlier this year business groups provided evidence of a harder line approach by HMRC and more recently the HMRC Working Together e-group discussed practical restrictions on getting agreements arranged. Several group members suggested that HMRC resourcing has been a major hurdle, in particular with problems getting through to the right people.

One user commented: “It appears they are swamped and the staffing appears to be too junior to make a decision. They seem to have little experience of dealing with a company”.

So with TTP becoming less and less available to businesses what alternatives are available?

Whilst temporary overdraft facilities may be available to some businesses, banks are generally reluctant to provide help unless existing borrowing is low and there is very strong asset backing within the business. Debt finance may provide more easily accessible cash, through solutions such as invoice factoring, and invoice discounting, where working capital is released against the debtor book to boost the business’ cash flow.

The problem with all these solutions is the long term commitment which is required, What if help is only required for a short period, for instance whilst the tax liability is being cleared?

In this case single invoice factoring may be the answer as it allows businesses to deal with temporary cash difficulties by selling individual invoices to the finance company without entering into a costly long term commitment. By accelerating the receipt of cash which is already due to the company through the sale of an invoice, urgent liabilities can be settled without the need for borrowing.

The cost of a single invoice factoring agreement is often much less than the penalties incurred by late payments.

 

11
May

Richard TurnerMicrosoft’s $8.5bn (£5bn) deal for the internet phone service Skype has once again thrown up discussion around the topic of valuation.

Valuation is not a precise science.  The founders or existing share holders want to maximise the value. An investor is typically much less optimistic about the companies prospects and more acutely aware of the risks, and therefore  wants to minimise the value.  This is a minefield that can damage a company and moral of the team even after it is successfully completed.  Years later founders can be resentful of deals that they thought underestimated the value and therefore robbed them of value.

So what is value? How can a loss making company with revenues of $9 million sell for $210 million; an idea on paper raise $10 million on a $20 million pre money valuation; whereas another company with revenues of £3 million making  £0.5million profit sells for £3million ?  Value depends upon an assessment of the future risks and potential and, in the case of a trade buyer, the strategic value and synergies that an acquisition can deliver.

Valuation Techniques

So how do these wildly different valuations come about? The answer depends upon why you are valuing a company and the techniques used. There are broadly speaking two types of approaches that are useful for valuing intellectual property based businesses: Discounted cash flow and market based approaches.

Discounted Cash Flow Approach: Conceptually all income/revenue based valuation techniques use discounting of the future as an underlying basis for coming to an assessment of the current value. The techniques vary but the assumption is that the business is worth some discounted sum of the future revenues or profit.  The key assumptions are what stream is being discounted and at what rate. In practice DCF approaches are very hard to use for early stage technology companies as the projected financials are often extremely speculative and the variables determining outcomes many and various. DCF works best when applied to companies with a proven business model and a reasonable history of performance.

Market Based Approaches: How can a loss making company be worth millions?  The answer lies in market value. Which is not so much a technique and more a hunch.  The buyers feel that it would give them a compelling edge in the market that would transform their strategy and/or there is a compelling proposition with an excellent team who have proved they could build a successful company.

A highly experienced American venture capital investor explained this approach as follows:
“we believe that we can exit for over $200 million  in five years time, we think that it will cost $15 million  investment to get to exit, our target rate of return is 10 times over the investment period, we think that to incentivise management requires them to have 25% therefore resolve that equation and you get a pre – investment valuation and that’s as scientific as it gets.”

Just in case you are wrestling with the answer it is $5 million.

For many early stage investors investment valuation is even less scientific. Many funds in the UK have a view that all technology businesses that they are willing to invest in are worth £1 million irrespective of the technology or the market.  This is not based on any assessment of exit value it is just a policy.  If pushed they will offer the management team a ratchet or options package determined by achieved exit valuations that effectively give the business a higher initial valuation.  In effect the approach is to say if you think its worth so much well lets see what’s achieved at exit and if it is much greater than our 10 times target you can get a bigger share of the upside.

Factors affecting Value

The biggest factor that affects valuation of technology companies is risk: market risk; technology risk; and management risk. An investor is looking at how to minimise these risks: does the technology meet a genuine unmet need or solve a real problem or is it a technology looking for a problem to solve; is the technology protectable and does it confer defensible competitive advantage or can it be easily re-engineered; is the management up to the challenge, can they work with investors, can they grow with the business.

As well as execution risk there is commercial risk – will anyone want to buy the business when an investor wants to exit.

Maximising Value
Technology businesses seeking to maximise value need to focus as much on managing the downside as emphasising the upside. This requires building the right management team; understanding the market and the value proposition in detail; getting the pricing right; creating partnerships with other businesses which can help take the product to market and create synergies.
Go to our resources section to download this article in full with additional case studies

 

 

10
May

Richard TurnerVenture capital is the provision of finance to unquoted companies. The investor effectively becomes a partner in the business. This varies from friends and family putting in £50,000 to a multi-million pound buyout deal.

All sources of venture capital have their “sweet spot” both in terms of sector and stages of the development of a company thus it is important to appreciate what stage you are at:
Seed corn. This is the development of an idea into the foundation of a startup. A typical example is the inventor in his garage obtaining funding to create an early proto-type of a knowledge management software product.

Start-up. This is a company that may or may not be ready to start trading but has a clear business proposition and well defined markets i.e. developing a working prototype into a product that can be sold. It typically has a core management team and a well-defined market strategy e.g. sell our knowledge management product to consulting businesses.

Early Stage. This is a business that is making sales but has yet to make a profit. This business will have ironed out many of the teething problems: recruited a sales force; produced a second version of the product; have some reference
clients; have a grounded business plan that is achievable.

Expansion. This absorbs over 50% of all venture capital funding and is used to grow an established business providing funding for: additional working capital; funding for a new product or service; moving into new geographical markets; capital expenditure.

Other uses of venture capital are: acquisition; debt replacement; management buyouts; buyins; rescue capital, and replacement capital.

For an overview of the Investment Process you can download our briefing paper from our resources section if you are interested in a lengthier overview on Venture Capital funding.

5
May

Richard TurnerIt seems to come as a shock to many people that the venture capitalist is in it to make money and lots of money! Most funds have a target return of 35% per annum.  This though is from a portfolio, which contains companies with widely different levels of performance.  Overall the performance of investee companies tends towards the third, third, third rule: a third of all companies invested in either stand still or fail; a third are moderate successes growing at between 10-20% per annum; a third are extremely successful with growth rates in excess of 100% per annum. To ensure that the fund meets its overall return most VC’s therefore look for returns on investment in excess of 50% per annum and frequently over 100%.

I have published a briefing paper which you can download from our resources section if you are interested in a lengthier overview on Venture Capital funding.

3
May

Jeremy LawrenceIn the second part of our overview from Jeremy Lawrence we look at the the key issues to consider in choosing the best solution for your business.

(See Part 1 for an overview of the main choices in the market for Single Invoice Discounting and Factoring or download the full article from our resources section)

1) Cost
No one wants to pay more than they have to but beware the headline numbers – they can be misleading.  The traditional factoring and discounting model usually includes an arrangement fee, a service charge (payable whether or not you use your facility) and interest paid on the money advanced. The interest charge is based on a %age over a standard rate, typically bank base rate.  In addition, there can be severe penalty charges if you try to cancel the contract before it has reached its end. Also, don’t forget the administration coast – you will be required to provide monthly reports on the ledger and the performance of your business, regular reconciliations of trust accounts (special bank accounts set up to receive money) and frequent audit visits from your provider – you may find that your accountant cannot deal with all of this and requires additional help.

It is important to take all these costs into consideration. The only cost charged in a spot factoring deal is the “discount” taken by the provider – this is the difference between the face value of the invoice purchased and the amount the factoring company pays for it. The charge is a %age calculated daily from the day you get the money until the day the invoice is paid.

The costs of spot factoring rate can appear to be high because all the costs of the service are built into the headline rate. As there are no add-on costs and no internal administration time to pay for, the comparative cost may be quite low. The costs are also easier to control – spot factoring is only used when it is needed. The invoice can be sold when funds are required and paid off once they are not so the amount of time you actually pay for may be much less than with a traditional factor. In general terms, traditional factoring and discounting will be less expensive in situations where there is a permanent, long term need for working capital finance. A temporary or occasional need for funding will usually be less expensive if spot factoring is used.

2) Administration
The traditional invoice discounting model requires the greatest administrative effort as the provider has to be given ongoing information on the status of their security. There is also an obligation to submit to audit as required by the provider.

Similarly, traditional factoring takes considerable administrative effort in supporting the factoring company’s requirement for information about all elements of the debt book. Where the factoring company takes responsibility for the management of the ledger and debt collection, the administration burden may be reduced but there is of course, a financial cost for this service. With spot factoring, there is no administration burden other than the submission of the invoice for funding. The relationship with the customer remains very much in the control of the client and collection of the debt remains the client’s responsibility.

3) Control of customer relationships
One of the big concerns for many clients is the loss of control over the hard won relationship they have with their customers. The potential risks associated with someone from outside their own organisation being in contact with their customer may be too high to bear. If this is a critical consideration, confidential invoice discounting is the only option available where the customer will remain completely unaware of the existence of the discounter. The downside for this is that the costs and the administration burden are high.

Under the traditional factoring agreement, the customer always knows that his debt has been sold to the factoring company. Although the invoice will be received in his supplier’s name, it will provide the bank details of a third party (the factoring company) on the invoice and statements, reminders and even telephone calls will come from the factor – someone with whom he has no direct relationship. Debt factors sometimes use call centre staff with potentially no interest in the business and whose only concern is getting the invoice paid. The client cannot control the degree of pressure the debt factor may use.

Spot factoring falls somewhere in between these two. Although the customer is required to confirm the validity of the invoice and pay the spot factor direct, rather than his supplier, once this has been done, the spot factor will have no further contact with the customer.

4) Availability of facilities

Traditional factoring companies will consider both the status of the debtor and the potential client’sunderlying business before extending facilities. Where the business is very young or is going through difficulties it is likely that facilities will not be extended or will be severely limited. Although a spot factor will examine the underlying business and take account of its future prospects, the main concern is that the invoice being purchased will be paid. As a consequence, very young businesses can often be funded and distressed businesses can also be eligible provided that there is a realistic prospect of impending recovery.

5) How long do you need the funding

This may be a crucial question. If the need remains significant for the foreseeable future the obligations associated with a long term contract are easier to justify. Traditional factoring is probably for you.  However, maybe you should also look at other funding options altogether. If there is a long term need to fund working capital, it suggests one of two things – either your business is growing so fast (and your debtor book with it) that you never expect the profitability of your business to catch up with the need for cash to finance all this new business. Alternatively, if your business is not growing, you should perhaps be looking at the profitability of your business – the implication is that either you gross margins are too low or your overheads are too high. Where the business’s need for funds is spasmodic or occasional, then spot factoring may be attractive as you can dip in and out to meet the specific needs of your business on a day to day basis.

Supposing your cash flow shows that for most of the time funds will be available but that for just a few weeks or months in the year there will be a shortfall. Spot factoring will iron out these spikes in cash demand without the need for long term lending contracts or running costs which you simply don’t need to incur. Once the initial paperwork has been put in place and the facility approved (which typically takes under a week) then you can normally get the cash on an individual invoice in under two working days. It is this ability to pick and choose when you draw funds, together with the speed and flexibility of operating the relationship and the very light administrative burden which can be attractive to many businesses.

Conclusion

Every business is different and has different financing needs. There is no single solution that suits all these different situations.  In choosing the right working capital finance model for your business, there are many factors to takeinto account. If the decision seems too hard to make, it may be that your accountant or financial adviser needs to be brought in. But here are a few simple guidelines to think about:

1. If you need continuous long term financial support then one of the traditional models will probably suit you best – being in a long term contract reflects your long term need so the issue of termination will only arise if you are unhappy with the particular provider you have chosen

2. If you need help managing your ledger and are happy for your customer to know about your relationship with the finance provider then Invoice factoring will probably provide the product you need.

3. If it is important that you keep your customer relationships completely in your control, you need confidential invoice discounting – just be ready for the administration burden that goes with that

4. If you only have occasional need for funding or you are not too sure whether when you will need it in the longer term, spot factoring will give you the flexibility to dip in and out of the facility.

5. If you want to keep it simple and have complete discretion over when and whether you use the service, again spot factoring provides this. Using spot factoring can provide a stop gap while you decide which direction your business is moving in.

6. Finally, if traditional sources have turned you down for funding, it is worth speaking to a spot factoring company as there are often situations where they can help when others can’t.
For more information or to discuss your working capital finance needs, call Jeremy Lawrence at Catalyst IFG on 0845 528 0788.

 

 

3
May

Jeremy Lawrence

There’s a myth in the market that factoring is the financing of last resort and that any business which has to sink this deep is on the brink of failure!

At one time this may have been partly true as banks happily gave overdrafts to anyone who walked through the door with a half decent business idea and a bit of a financial plan. But nowadays, the reality is very different. Invoice discounting and factoring are the primary sources of working capital finance for many businesses in the UK and are often the only way a bank will even consider supporting its SME customers.

Banks now realise that the debtor book is usually a company’s best and most easily realised asset, should anything go wrong. For some considerable time now, they have taken the view that they can lend more with less risk by taking control over their customer’s debtors in one way or another. So now that debt factoring has become acceptable – even the norm, rather than the exception – it has become crucial that businesses looking at working capital finance should shop around for the factoring arrangement which best suits their particular situation. Factoring is a sophisticated product these days with many different options available. As with all mature markets, choices have grown and that, the obvious solution is not always the best.

So what are the main choices?

Traditional factoring: Here, the factoring company takes ownership of all your debtors – the debtor book. Although the factor will take control of the whole ledger, certain debtors may be reserved (i.e.excluded so far as lending is concerned) usually because they are too old or the sale contract is not considered strong enough or because of a bad experience the factor has had somewhere else.
The factoring company will then make an amount available to the business based on a %age of the unreserved debtors. The percentage is typically from 70% up to 90% depending on the view that is taken of the strength of the ledger and the underlying business. The factoring agreement usually allows the factor to vary this percentage at short notice.

Invoice factoring companies often take over the complete administration as well as ownership of the ledger, including debt collection and credit insurance in which case the client company sacrifices control of its relationship with its customer once the sale has been made.
Factoring contracts are usually for a minimum period of two or three years with penalties for earlier termination

Invoice Discounting: The traditional discount model is very similar to factoring except that the invoice discounter provides a loan to the client – the debtor book acts as security. The amounts available will typically be similar to the debt factoring arrangement.

Generally, in an invoice discounting contract, the client retains control of the ledger and the debtorwill often not even be aware of the arrangement (confidential invoice discounting). The administrative burden on the client is often quite high as the discount company requires detailed monthly reports on the state of the ledger and will usually audit the returns for accuracy. Audits canbe frequent and errors can result in penalties.

Spot Factoring: Spot factoring differs from traditional factoring  in that the provider buys single invoices, rather than the whole debtor book. Each transaction stands alone so there is no long term contract and no standing charges. The client has complete discretion as to when he uses the facility. As with traditional factoring, the debtor is always aware of the transaction but there are no reporting requirements so management of the facility is very simple. The Spot factor may take a charge over the rest of the ledger but all aspects of its management (including collections) stay withthe client and the charge is only of relevance for as long as the particular invoice remains unpaid.  Spot factoring can be thought of as a “pay-as-you-go” option, used as and when it is needed and with no costs when it is not. Agreements are quick and simple to put in place and there is minimal administration at any point in the transaction.

See Part 2 to discover the key issues to consider in choosing the best solution for your business? Or you can download the full article from our resources section.