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Supply Chain Finance for SME’s: Lessons from Greensill

Supply Chain Finance (SCF) is a useful way to fund SME’s. In this article we’ll explain what it is and why it’s useful. We’ll also analyse the recent collapse of one of the world’s most popular SCF providers, Greensill and finally take a stab at predicting what SCF will look like in the future.

Greensill Capital Supply Chain Finance

What is Supply Chain Finance and why is it useful?

SCF is a form of financing typically used by Small to Medium Enterprises (SME’s) when supplying products to larger companies. It’s often called Reverse Factoring because the SCF company uses the supplier’s sales invoices as security for the loan.

How is this different from regular Debtor Finance?

The major difference is that the customer is borrowing the money, not the supplier. That sounds great for an SME – no credit check for the supplier and because the customer is generally a large corporate the interest rate is lower.

Wait, what interest? You said the customer is borrowing the money?

That’s right – the customer is borrowing the money to pay the supplier but they pass the interest cost on to the supplier. In practice this means the supplier can choose to be paid sooner than the agreed payment term but the amount will be reduced by interest. Because the customer is larger they can generally access funding at a lower rate than the supplier can. This means it can be cheaper to use SCF than Debtor Finance!

Should my SME use SCF if it is offered?

Overall SCF is a relatively cheap and easy way to fund invoices with a few potential drawbacks. If you are able to access it via a large customer make sure you are comfortable with the rates and check it won’t conflict with your existing Debtor Finance facility.

You should also be aware that you’ll be relying on the funding agreement between your customer and the SCF lender. If that fails you may have a cashflow problem!

ProCon
No Credit CheckLimited to specific customer/s
Cheaper interest ratesSCF lender risk

What happened to Greensill?

Greensill Capital was founded in 2011 by Lex Greensill, a Bundaberg boy from a farming family who became a banker (Morgan Stanley, Citigroup). His family’s experience of cashflow problems selling sugar cane and melons inspired him to enter the world of invoice financing. Greensill Capital grew its SCF business quickly by converting its lending into notes and issuing bonds which allowed it to access more funding than if they had relied on a single bank (the traditional SCF model). Australian customers included UGL, Telstra, Vodafone, and Airbus.

Expanding beyond traditional SCF lending

Greensill expanded worldwide, and extended its SCF offering to consumers by purchasing Australian startup Earnd. A lucrative contract with UK’s National Health Service allowed Doctors, Nurses and other staff to drawdown their salary early (paying interest for the privilege). It also began lending to riskier businesses, taking out insurance to cover the risk of default.

Risky lending

One of those riskier businesses was Sanjeev Gupta’s group of companies. Gupta Family Group (GFG) companies accessed Greensill SCF funding for invoices including between their own companies. These are now suspected to be sham invoices. By the time Greensill collapsed their exposure to GFG was around $5 billion.

Criminal investigations

The suspect GFG invoices were eventually noticed by the German financial regulator BaFin. BaFin conducted a criminal investigation into Greensill Bank and concluded that Greensill had lent money to GFG for invoices that weren’t real.

Bye bye Insurance

Greensill’s loans were insured through a subsidiary of Insurance Australia Group (IAG) which was later acquired by Tokio Marine.

In 2020 Tokio Marine advised Greensill that some of the insurance policies were potentially invalid. They also said they would not renew the policies in the next year.

The end of Greensill Capital

Greensill Capital filed for Administration in March 2021. They had

What’s the future for SCF?

The Greensill saga highlights the risk for an SME in relying on an SCF arrangement. If you have one of these arrangements in place your cashflow is at risk if the facility suddenly ceases. Because it’s probably related to your largest customer this could be a big problem so it’s a good idea to find an alternative source of funding if needed. But apart from a Greensill-style collapse, what other issues could harm your customer’s SCF facility?

Regulatory changes

In the wake of Greensill regulators will increase scrutiny of these arrangements, and investors and insurers will be acutely aware of the risks inherent in this type of lending. This will probably lead to rate increases and even cancellation for some smaller, riskier customers.

Accounting changes

SCF is generally not visible in the financial statements. They simply show those liabilities as Trade Creditors instead. Mostly they don’t show enough detail to see if amounts are owing to suppliers or to SCF financiers.

The accounting profession is moving towards presenting SCF liabilities separately on the Balance Sheet so its clear they represent short-term loans rather than Creditor liabilities. Along with this will come better disclousre of the nature of the debt.

This is boring accounting stuff, why is it relevant?

It’s relevant because this will affect the types of financial measures that affect how businesses can attract lending and investment. The result could be that some businesses decide its better for them to close down SCF facilities!

What to do if my SME is offered SCF?

The lure of being able to access customer payments immediately is very strong, and can be very helpful to your business. Whether you’re considering a new SCF arrangement or evaluating the potential impact of your current SCF failing, make sure you:

  • Model the cashflow impact with and without SCF;
  • Forecast the P&L impact of the additional interest expense;
  • Check if the SCF conflicts with existing or planned Debtor Finance facility.

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