Fund-a-mental: The real problem with clouds and managed services
Get your money up front if you want money up front
Comment It’s all very well dodging the economic downturn by hopping on the cloud bandwagon, but you might find this also puts you out of reach of the industry’s established funding models.
It’s a truism that one of the problems holding back British business is getting access to credit and other forms of funding. The government has done its perceived bit through quantitative easing (QE), and has almost bashfully cajoled banks into trying to lend more, without much success it appears. The banks remain non-committal, hanging onto cash with an eye on bank capital adequacy, risk, compliance and Basels II and III. When they do lend to business, they charge more and are far more aggressive in securing a much higher percentage of the loan. Preferably the lot.
My own recent conversations with resellers suggest overdraft levels have been cut, frequently without notice, while alternative funding through receivables/debtor factoring or invoice discounting has been capped at lower levels with reduced draw-down.
Channel players, it has to be said, are not the best at managing working capital. They meekly accept longer terms from their customers, fail to chase aged debt for fear of upsetting clients ( a misplaced notion that can prove fatal) and in days of old when tin was more prominent, they rarely managed inventory adequately. I recall some with significantly aged debt with no provision attached who when questioned, said a ‘long standing dispute’ was the reason for non-payment. If they’re not doing business and they haven’t paid you for nine months buck up, take action, resolve the dispute and achieve some form of settlement.
‘Cash is king’ is a rallying call and a sale is not a sale until it’s paid for, but for any business, cash and access to additional funding to grow and expand is critical.
Asset-based lending, taking a company’s largest asset in book debt created and lending against this, has long since been predominant in channel funding. Funders secure advances with fixed and occasionally floating charges over company assets, perform routine audits are generally happy if paperwork and control meet requirements.
The question today however centres on the interpretation of tangible debt, something that remains uppermost in the eyes of receivable funders.
Debtors - or more politely, trading customers - who are yet to pay are typically the largest current liquid asset on a company balance sheet, well in excess of 50 per cent of total assets. Factoring along with invoice discounting remains the choice of many in terms of business funding.
This was easy in the days of product delivery. Audits would show a trail of customer enquiry, supplier quotation, order placement, invoice and a signed delivery note. Sure, there were a few dodgy operators who falsified clients and invoices as well as some less than honest funders known for providing funding with associated up-front fees and pulling the plug relatively quickly.
One supplier in the early 90’s indeed insisted those applying for credit indicated if they factored or not and if they did, this was counted as a negative – quite wrong of course.
Sale of software and licences did at first present issues in terms of receivables funding, more so when this was not boxed but effectively sold online. There would still be an enquiry, quotation, order and invoice but no actual proof of delivery until the licence was activated. Somehow most funders got their head around this but others sought refuge in reduced draw-down availability and higher charges. When services crept in, they were sufficiently small to be enclosed within an invoice for product delivery and also grudgingly accepted.
So what now of managed services, hosting and recurring revenue on the back of fixed and sometimes long term contracts? How will funders view this shift from traditional product based or largely product based activity to one with higher density of service provision?
The signs are not good.
Tangible debt, something they can touch, see and has undeniably been delivered or provided is more secure than one in which a service is billed against an initial contract and charged at regular intervals, whether the service is actually delivered, used, or not, as the case maybe.
Funders are concerned that non-fulfilment of services is likely to lead to non-payment of the invoices financed. Furthermore, the nature of such contracts for services where the original contracts are either missing or not contractually agreed at the onset, weaken the lenders position in the case of Reseller default.
The recent case of 2e2 has highlighted billing of service revenue in advance or in advance of actual delivery, whenever that may take place. Lending against an asset that has not been delivered or created or which rests entirely on a pre-supposed initial agreement, terms applied and the short and longer term ability of the business to provide this service, is just not an option.
For proof, consider that in the case of 2e2, the statement of affairs suggests only £5m out of a total of £35m receivables are deemed collectable. This will certainly make receivable funders nervous and far more critical.
Those basing their model entirely on managed services will find themselves at odds with funders likely to severely restrict or maybe decline receivables funding and owners may perhaps turn to VC funders, business sale or private equity investment to provide the means for growth.
Those shifting from an 80/20 ratio of product/services to one of 60/40 also face significant issues, not only while this shift occurs but thereafter too, though overall revenue values may decline and lessen the impact.
Many small to medium sized MSP’s deal with large systems integrators. Concentration of debt limitation applies and SI terms may prohibit assignment to a third party which funders always wrongly misinterpret as not being able to assign to a funder.
The banks’ current position is no help and while new entrants smart enough to see the opportunity may step into the breach, I don’t see traditional players reviewing their stance on this type of client billing. They simply don’t see it as secure enough to lend against. ®