When businesses are looking for funding, there are many questions they need to ask – some more obvious than others. In our series of dispelling the myths, we are taking a look at concentration levels and how funding businesses where high concentrations exist may not be as straightforward as they seem. We ask Brit Pearce, sales director at Pulse Cashflow who aims to bring greater transparency to the topic.
What is a concentration limit?
If a business has a customer or debtor which accounts for a large percentage of their overall sales ledger then it is seen as a concentration. Put simply, if a business has a ledger worth £100,000 and one customer accounted for £50,000 of it then the concentration level would be 50%.
In situations like this, funders put a concentration limit in place which limits the amount of funding they will provide against the debtor with high concentration. For example, when applying for an invoice finance facility you may find that funders quote a range of concentration limits. Is the higher the limit the best one and therefore the one you should choose? On the face of it yes but sometimes things are not always as simple as they seem and choosing a lower limit may not result in the best outcome.
What should I be considering when comparing concentration limits?
When you are putting a funding facility in place you are looking to access a specific amount of finance to support your business. Concentration limits can impact on this. With a factoring or invoice discounting facility, concentration limits on debtors will restrict the amount of funding against a particular debtor and therefore the overall amount of cash available.
Comparing concentration limits offered by funders may demonstrate how much extra funding you could access from one funder to the other but sometimes all is not what it seems. There are many areas that should be considered to bring greater transparency to the whole area of concentration limits and the amount of funding available to a business.
Being responsible: Firstly, some funders focus purely on how high the concentration limit is, alluding to the fact this is good because you have more funding available. However, a funder has a duty of care to their client to provide good advice and should act responsibly. If a client has a 70% concentration with one customer, then that presents a real risk to not only their business but also personally if they have secured the facility against a personal guarantee, if that customer fails to pay an invoice or indeed their business fails and cannot pay monies owed.
Verification plays a part: Verification of the invoice plays a big part in how much funding a business receives. If the client is supplying a product or service to a single customer where it represents a 70% concentration limit and there is a problem with product quality and the customer rejects the invoice, then the factor will not fund that invoice because it has failed verification and the invoice is put into dispute. Therefore, the client suffers a restriction on the amount of funds available and this could be very damaging to their business. Equally, some funders implement more stringent verification processes in order to withhold funding as a means of reducing their overall exposure to the client caused by the high concentration limits. Therefore, that high concentration limit promised upfront is not necessarily delivered because verification processes can end up restricting funding.
How do factors mitigate the risks of high concentration limits?
There are a few ways that factors can mitigate the risks they face when they offer high concentration limits such as:
Lower Initial prepayment levels: An invoice finance agreement will document an Initial Prepayment percentage. Essentially this represents the % value of an invoice that the funder will make available to the client on each and every invoice raised. The difference between 75% and 80% of the invoice value can be significant for some businesses. This is often used to restrict the level of funding to a business. Be wary of the “up to” statements that some factors use. Check your offer letter which should state the size of the facility and the initial prepayment.
Using credit limit values: The headline concentration limit set on a debtor might be high but it will be subject to a credit limit value. What this means is that when the funder verifies the debtors, they will identify the debtors credit limit. The small print will tell you that funding facility works on whichever is the lower of the two so if the credit limit is lower than the concentration limit, funding will once again be restricted to the credit limit level.
Increased use of personal guarantees? Most businesses will give a personal guarantee to secure a funding facility. A business owner needs to ask themselves if they are funded over their credit limit? If they are, they may be happy about this but should consider what would happen if something goes wrong as it could result in putting their personal guarantee at risk. At Pulse Cashflow we work with our clients to review their overall credit position and the concentration limits provided to provide added protection to them as guarantors. Calling on a personal guarantee should be the last port of call for any funder but is often used as a means of reclaiming monies owed, particularly where higher concentrations are given and there is no other means of recovery.
Using bad debt protection to protect your risk? Bad debt protection is a sensible way of protecting your business and potentially any personal security as it provides the funder with an alternative means of recovery to enforcing on a guarantee. Pulse Cashflow’s funding facilities include bad debt protection as part of the overall solution and our single. fixed monthly fee covers the cost of funds you use, our collections service as well as bad debt protection. However, businesses should be aware that claiming on any policy can affect credit limits.
At Pulse Cashflow, transparency under pins everything we do. Our advice to any business or their advisor is to challenge the detail behind the headline concentration limit – what restrictions are being put in place to compensate for potentially high concentration limits?
As we believe in transparency in everything we do, we deal with concentration issues/restrictions differently from other funders. Our flat structure means that business owners speak directly to the underwriters enabling concentration limits to be quickly agreed upfront. They are not subject to an indicative offer only to be overturned later by an underwriting team.
All too often funders make an offer based on unrealistic concentration limits only to have their underwriters reduce the offer at the 12th hour! £25m of our clients’ turnover benefits from funding in excess of a 25% concentration limit of which 10% is over 40%. We don’t lead on high concentration limits, instead our reputation is based on delivering a committed offer quickly which we stick to and one which represents a duty of care to our clients.
We take the time to make sure our clients understand exactly what to expect and we don’t hide behind other parts of our process. The amount of funding we agree upfront is not subject to hidden restrictions which we hide behind. We are transparent too in other parts of our business. Our single fixed monthly fee which our clients agree upfront, they pay just that, with no additional costs incurred throughout the course of doing business with us. We do not over-promise only to let our clients down.
One of our clients summed it up “Having access to the key decision-makers meant we could discuss the situation and obtain a fast decision delivering a flexible and fair funding deal with a 75% concentration limit within 11 days to support our ongoing business”.