What is the difference between ‘Factoring’ and ‘Securitisation’?
Factoring and securitisation are both receivables finance techniques used by businesses to raise funds, but they differ in how they achieve this goal.
Factoring vs. Securitisation
The two solutions have much in common and have even started to converge. Over recent years, many corporates have sought our help to provide proposals for both products, allowing them to compare the benefits, the limitations, and the costs of both factoring and securitisation to find the right solution for them.
Factoring allows companies to sell their book of accounts receivables directly to a funder in exchange for finance – it is a direct transaction between the funder and the company. This is an off-balance sheet treatment for the company as the funder is the now the owner of the receivables.
Securitisation, on the other hand, uses an intermediary called a Special Purpose Vehicle (SPV) to ‘purchase’ their pool of receivables. An SPV is an entity set up by the selling company, and are independent of the company’s balance sheet. The SPV then sells the financial notes of these receivables to the funder in exchange the finance, which is then passed back through the SPV to the corporate. This is an off-balance sheet treatment as well because the SPV is the now the owner of the receivables.
- They are both a receivables finance solution
- They both allow companies to get their outstanding receivables off their balance sheets
- The risk associated with the lines of credit are based on the payment history of the company’s book of receivables
- Funds in a securitisation don’t pass directly from funder to the company
- In order for a securitisation to work, a company needs a large book of receivables to pass through the SPV due to the complexities of the structure
- In a securitisation the risk sits with the SPV rather than the company
Factoring, also known as invoice discounting, is a receivables finance transaction in which a business sells its accounts receivables (invoices) to a third party, known as a factor (funder). The factor then assumes the responsibility for collecting the outstanding debt from the business’s customers. Factoring can help businesses improve their cash flow and access funds quickly, but it comes at a cost, as the business will receive less than the full value of its invoices.
The first recognisable examples of factoring date back to ancient Rome, where wealthy producers employed an agent, or factor, to manage the sale and delivery of their products. The factor would typically receive a payment equating to a small percentage of the value of the products sold.
Typically, factors were given the products on consignment, however advances in communication and transportation no longer made it necessary for an exporter to send goods to someone on consignment, and instead, goods eventually were sold directly to factors. In conjunction with the development of factoring, many factoring houses have become subsidiaries of banks, and the product offered typically involves three main services:
- The direct purchase by a factoring house of receivables disclosed to the debtors. However, Factoring programmes don’t necessarily always have to be disclosed to customers, and confidential factoring is now commonplace.
- The debtor credit risk cover, often supported by trade credit insurance policies.
- The servicing of receivables, i.e., the collection and recovery of the receivables.
Initially, factoring was generally offered at a local level. However, the product has now evolved as the demands of customers have changed, and now cross-border Factoring is a widely used product.
Factoring: key takeaways
- The invoice/receivable is sold directly to the factor (funder).
- It receives off-balance sheet financial treatment (subject to auditor confirmation) as the receivables are now the property of the factor.
- Lending is based off the payment history of the receivables book.
Securitisation involves the packaging and selling a pool of financial assets into a marketable security. The cash flow from the underlying assets is then used to pay interest and principal on the security. Securitisation allows businesses to raise funds by selling off assets, which can help them manage risk and free up capital.
Securitisation is a more complex receivables finance product than factoring, due to the number of moving parts and the structures involved. Like factoring, it consists of the sale of receivables, however the buyer of the receivables is a Special Purpose Vehicle (SPV). An SPV is an entity that is set up by the selling company that effectively ‘purchases’ the receivables and in turn sells the security notes of these to the funder. There are two reasons why an SPV is used:
- The SPV ensures that the assets are legally separated from the sellers and owned by an entity that is bankruptcy-remote.
- The SPV also pools all the receivables together and provides a homogeneous basis for the financing.
The risks of the portfolio may be allocated to different investors, depending on the nature, ratings or priorities. Investors in trade receivables securitisation are often conduit vehicles, owned or sponsored by banks, that place securities on the capital markets at attractive conditions.
While factoring is used by both large and small businesses with limited access to credit, securitisation is typically used by only large businesses that have a large portfolio of assets to sell.
Securitisation transactions have expanded in both size and scope and are now often global. In parallel with this trend, new investors have come to invest in more risky tranches, providing more financing to the corporates. Finally, over time, the minimum transaction size has decreased to around $50m or less.
Securitisation: key takeaways
- Funds are managed through an SPV rather than between the selling company and the funder.
- Only a business with a large pool of receivables can take advantage of this trade receivables solution <link to trade receivables securitisation product page>.
- The structures achieve off-balance sheet treatment (subject to auditor confirmation) as the receivables are the property of the SPV.