Excerpted from "What Every Banker Needs to Know About Working Capital Lending"
Most lenders are uncomfortable with working capital lending because the collateral securing the loan is
"invisible." However, the collateral is only invisible because of a common application of this collateral
base that is frequently used called batching.
Batching
Batching is when a group of assets of similar style or class are grouped together to become one unit of
collateral. A dollar value is then assigned to this collateral unit. Batching originally evolved in order to provide working capital to businesses with a large number of
accounts receivable. Because of technology barriers, batching became popular and, over the years, it has
evolved into the most common application of working capital lending. An example of batching is as follows:
A business has 3,000 specific accounts receivable that are totaled up to create what is called an
accounts receivable batch. This batch has a defined amount, which is the aggregate sum of
all the accounts receivable added together. The aggregate amount (accounts receivable batch) can
easily be written into a working capital formula, and the lender can agree to give a certain
percentage of the aggregate amount to the business owner.
The problem with this approach is that each receivable in that batch is in reality a separate piece of commercial
paper. Each receivable has its own defined characteristics, its own life, and its own particular points
that make it good, bad, or something in between.
Although the batch system is easy to understand and simple to administrate, it provides the lender with
no real security since the lender has no visibility into the individual pieces of commercial paper that
make up the batch. If the business should take a hit and the lender should need to liquidate the collateral,
in most cases, the lender wouldn't even know where to start.
In the accounts receivable world, taking a batch of accounts receivable as collateral is like grabbing
an entire subdivision of homes without having any idea of the specific nature of each of the homes within
that subdivision. To make working capital loans without validating the collateral behind it prior to
funding would be like making real estate loans without ever verifying the existence of the buildings.
Lenders know that without verification and validation, no loan can ever be determined to
be safe. This is the precise reason most lenders feel that account receivable collateral is invisible.
To remove the invisible nature of accounts receivable when used as collateral, the batching process
described above must not be used.
The key to making this type of lending a reality is to have an invoice-specific system with complete
automated visibility of the validation and verification of each individual account
receivable.
Validation and Verification
Validation refers to making sure the invoice is "real" and verification relates to verified accuracy of
the information on the invoice itself. Validation and verification is something that lenders do regularly
when they make loans. They validate and verify that the real property exists and that the equipment that
they are taking title to exists. They also get the specific identifying characteristics of that collateral
and tie it to their lending agreement.
Validation and verification of receivables should be no different. Why accept a batch when you can
actually have line item specific information on each receivable you are taking a lien position on?
The profit margin created in this type of lending product is usually ten times the amount of a loan
that would be secured by a bank CD. As long as the accounts receivable that are validated and verified
are from payers that have good credit, the liquidation of those receivables should always provide a safe
and secure working capital loan.
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