What is receivable assignment?
A receivable is a balance that a customer owes a business. You'll often hear about receivables in the context of accounts receivable, which are the payments a business expects when it has delivered goods or services that customers haven't paid for yet.
The business expects that these IOUs will be repaid, though there is a chance that the buyers of its goods or services may not ultimately make payments (we covered this concept of payment risk in our post on factoring).
Receivables matter in asset-backed lending and fintech cash flows because receivables are the collateral that borrowers use to secure, or serve as collateral, for a credit facility or warehouse line of credit.
When a borrower assigns a receivable to a special purpose vehicle (SPV), it is giving a lender the right to the future payments of that receivable. Receivable assignment, at the most fundamental level, is when a borrower provides customer- and receivable-level metadata to a lender and signs documents that transfer legal ownership of the receivable to a bankruptcy-remote SPV (which is controlled by the lender).
It's as if the borrower is saying to the lender, "Here are the payments I'm owed by customers. When they repay me, you will have the right to those payments."
Why is receivable assignment difficult?
For borrowers with limited origination history and a single credit facility, receivable assignment is a relatively straightforward part of the funding request or borrowing base generation process.
However, receivable assignment becomes significantly more operationally and financially complex as fintech startups and other lenders bring on new credit facilities or decide to keep some of their originations on their own balance sheet.
In a single-facility situation, the borrower often decides to pledge all receivables to the lender. In that scenario, the borrower is simply pasting its full loan tape into a borrowing base template every week. There is no data sorting or preprocessing involved; the borrower just pledges all receivables to the lender.
With multiple credit facilities, the situation gets more complicated. Different credit facilities will have different credit agreements that outline different eligibility criteria or concentration limits. (A simple hypothetical might be a student loan company that operates in United States and Mexico, and has one asset-backed credit facility, or lender, for each country.)
Borrowers with multiple credit facilities are likely to run into two types of challenges with respect to receivable assignment: operational challenges and optimization challenges.
The operational challenges include questions around record-keeping: What is the system of record for tracking receivable assignment? Will the "owner" of a receivable be tracked in a loan management system (LMS) like LoanPro? How will assignment information flow through to the servicing workflow (i.e., what happens when a customer repays)? How can the capital provider be given assurances that the composition of a borrowing base has not changed, from one draw request to the next? How can a subset of a loan tape be automatically pulled from an LMS and inserted into a borrowing base report?
The optimization challenges include: What are the rules for determining how receivables are assigned to different capital providers? How might these rules change when keeping receivables on balance sheet is an option? What algorithms or formulas are used to determine the optimal mix of receivable assignment between different credit agreement rulesets? What systems are used to ensure that borrowers do not pledge ineligible receivables to a capital provider?
The operational challenges of receivable assignment could cost a company hundreds of thousands of dollars, but the optimization challenges could cost a company millions--even if that company has a relatively small borrowing base. That's because companies without a plan for managing receivable assignment often assign ineligible receivables to credit facilities, or continue to pledge the same types of receivables even after a concentration limit has been breached.
It's not uncommon, in those situations, to see a company pledge $10 million in receivables, but only be able to borrow $5 million from their capital provider.
How will receivable assignment affect the future of lending?
Embedded lending and point-of-sale lending will likely see significant growth over the next decade.
However, as new players enter the space, there will be a "race to the bottom" when it comes to rates offered. The winners of the industry will be those companies that are able to formulate and execute capital strategies that grow with their companies, since those players will be able to offer their end-users the lowest rates. Leading companies will likely be able to raise credit facilities, hire capital markets personnel, and move on to multiple credit facilities or new forms of financing in a financially and operationally streamlined manner.
In short, the ability to assign receivables efficiently will determine the winners and losers in embedded lending. Companies that are able to get "full credit" for their receivables will see a higher effective advance rate and higher net interest margin, and will reach profitability more quickly. Companies that assign receivables haphazardly, or without rules and audits for efficiency, will end up with relatively low advance rates and will not be able to make the most of their credit facilities.
Want to learn more?
Finley is private credit management software that helps companies with asset-backed loans save time and money by automating routine debt capital management tasks like borrowing base reporting, receivable assignment, and alerting. Today, Finley manages over $3 billion in debt capital for customers like Ramp, Parafin, and Arc. If you're interested in learning more about software that can help you streamline your debt capital raise and management, just schedule a demo or take a self-guided product tour. We'd love to chat!