Cash Flow 2.0: An SMB Auctions Off Receivables

Nakina Systems boasts an elevator pitch that plenty of small and midsize businesses (SMBs) would envy. The venture-backed company, a former Nortel spinoff, has a 10-year track record developing network management software for telecommunications providers. Its global customer list resembles an industry who's who list: AT&T, Verizon, Time Warner Cable, and so forth. Its sales contracts are of the multi-year, multi-million-dollar variety.

"That's the good news," Nakina CFO Jacquie Arthur said in an interview. The bad news: Arthur has to pay Nakina's 80 employees every two weeks, among other recurring operational expenses. "We have very, very lumpy cash flow in, and very steady cash flow out."

If Arthur has just received a seven-figure check from a large customer, payroll's hardly a problem. But if Nakina's software is still in trial or hasn't yet been accepted by the customer, or if a customer is simply dragging its feet on payment--a problem plenty of SMBs face--Arthur might have to deal with a cash gap. Compounding the challenge: Cash ain't cheap, especially for a smaller technology company like Nakina.

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"When you're venture-backed, the cost of raising additional money is very, very high," Arthur said. "Doing another equity round just to put some safety money on the balance sheet is very dilutive to the existing shareholders." Traditional banks, on the other hand, "want to lend money when you don't really need it, especially in today's environment."

Arthur came across a better option almost by accident--she saw a company called The Receivables Exchange (TRE) on a customer's vendor site. TRE is part capital exchange, part eBay-style auction marketplace. Sellers put their accounts receivable up for auction; buyers place bids on what they'll pay now to the seller. Arthur saw significant appeal--if it worked well, it was a significantly less expensive way to free up cash flow than her other options. After doing her due diligence, she saw little risk in giving it a try.

Nakina has since sold receivables ranging from as little as $50,000 to as much as $2 million--at the time, one of the largest transactions in TRE's history. Arthur has yet to do a transaction she later regretted: "It's been wonderful for us." It helps that she's a C-level finance pro; her client list helps, too. Because buyers aren't too concerned about Nakina's customers eventually paying their tabs, Arthur's able to get the best possible prices for her invoices. "Our customers are AAA credits--better than the United States," Arthur said. "It shows you can sell a good receivable in this market based on the quality of the account--in fact, the bigger [transactions] have gone better than some of the smaller ones."

Sellers can't be fly-by-night operations; they must meet minimum criteria for time in business and revenue, for example. Buyers are typically banks, hedge funds, and other institutional investors.

An example transaction: If a seller wants to put up a $100,000 receivable for auction, it sets a "minimum advance"--the minimum percentage of the total amount owed that it will accept--and a "maximum discount fee"--the amount it's willing to pay the buyer. So the seller might set a minimum advance of $80,000 and a maximum discount of $2,000. If Buyer X offers to advance $85,000 for a $1,500 fee, and Buyer Y offers $90,000 for a $1,000 fee, Buyer Y wins. The seller gets its $90,000 within a day or so of the auction's closing. When the $100,000 receivable is paid by the seller's customer, TRE sends the seller the difference between the invoice and the buyer's loan, less the discount fee, and the buyer gets its original investment, plus the discount fee. In this example, the seller would receive $9,000 and the buyer, $91,000.

Arthur typically sets three-day auctions; bids might come in immediately, or they might take a couple of days to flow in. Sellers can also name a "buy it now" price that closes the transaction immediately. "You set your buy-it-now price a bit aggressively, like you would on eBay," Arthur said.

The end result is the same--the seller gets paid almost immediately after the end of the auction, instead of waiting 30 days or longer for the invoice to be settled. Arthur said she likes TRE because it's generally predictable--not a word often used these days to describe money markets. "It is a different way of solving a problem, and very efficient," she said. While a non-finance executive might have a steeper learning curve, Arthur thinks CEOs, owners, and other managers can use the platform; TRE's trading desk adds a human element to the process that helps less experienced sellers ensure they're not leaving money on the table.

While Arthur's a satisfied seller, she notes that putting receivables up for auction is not without its concerns. Arthur wasn't comfortable with the idea until she was assured that Nakina's customers wouldn't know that their invoices were changing hands; TRE promises anonymity. (Indeed, a different TRE seller that I contacted decided it didn't want to do the interview, and another didn't respond to an initial request.)

Arthur is comfortable discussing the process in general terms, but still wouldn't necessarily want clients to know their invoices were sold. It's essentially an image problem, especially for a small company with very large customers. "They want to make sure, even though we've been in business nearly 10 years, that we're going to be in business for the next 10 years," Arthur said. Customers care about Nakina's financial security. Arthur does too, of course--but unlike her customers, she must also care for Nakina's cost of capital. That's where TRE has been a boon.

"For an early-stage software company, in particular, it's perfect," Arthur said. "Our cost of capital through TRE is significantly lower than it would be any other way."

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