Receivables Finance: Innovative approaches to unlocking Access to Finance for African SMEs
Restricted access to finance for SMEs remains a roadblock to growth for economies worldwide. Africa remains no different, as SMEs typically provide 50% or more of the workforce in most countries, yet the SME “funding gap” perpetually totals in the billions of dollars. SMEs are continually frustrated by raising capital from traditional funding channels such as banks, who still typically require traditional (and expensive) information sources such as audited financial statements that few SMEs have a consistent need for or collateral security that few SMEs have access to. The current pandemic-induced economic crisis is accentuating this situation, with SME demand for funding increasing at a time when bank lending will be, in many instances, less active to these companies.
Against this backdrop, an increasing number of alternative funders and funding platforms are working in these markets to unlock this finance. Increasingly banks are also using this product as a preferred risk-managed tool to fund SMEs. The models focus on receivables finance, which broadly defined is a form of asset-based finance that uses outstanding invoices as the essential collateral securing the loan. “Receivables finance” can take the form of traditional factoring activities – for example, full turnover or single invoice discounting – as well as “reverse factoring”, which is debtor-led typically via an large so-called “off-taker” such as a retail supermarket chain, construction company, government body or multi-lateral organization. Also referred to as “supply chain” or “value chain” finance, the financing principal is the same as factoring except “reversed” to focus on a typically larger debtor that is likely a better credit risk than its smaller SME suppliers and thus is used as the anchor counterparty to motivate lending from traditional financiers. The institutions who provide this funding stream to SMEs need funding themselves in the wholesale market. Verdant Capital is responsible for a USD 30 million invoice discounting facility in Africa, providing such wholesale funding to institutions.
Increasing digitization and supply chain complexity are two trends that have supported alternative funders to creatively finance SME receivables finance mechanisms. These trends leverage the relative ease at which invoices can be digitized to serve as financeable collateral and ultimately monitored via online platforms, enhancing both liquidity available to SMEs and risk management practices to funders who often may be located at great physical distances (even across borders) from the SMEs.
This article is a summary of an article published in Making Finance Work for Africa’s “Africa Finance Forum Blog” in June 2020. The full article is also posted on our website: www.verdant-cap.com/knowledge.
Sources: Small Business Unit of South Africa (“SBI”), 2018 Finfind study, sponsored by the South Africa SME Fund, SME Finance Forum and Oxford Business Group