Despite invoice financing becoming increasingly popular, it is no new financial phenomenon. In essence, invoice financing refers to the process of selling unpaid invoices to third parties in order to get access to a percentage of the value of that invoice quickly.
Depending on the type of invoice financing, the invoice is either sold to a third party for a certain percentage of the full invoice value, after which this third party is also responsible for the collection of the invoice (factoring). Or a certain percentage of the value of the invoice is lent out to the company. That is then repaid once the invoice has been paid, along with a fee and discount charge (invoice discounting).
Tokenisation on the other hand refers to a new way of handling digital assets. Specifically, by turning them into a ‘token’ which lives on a blockchain. This allows the tokenised asset to be easily tracked, transferred, and more. But how do these two work together?
Let’s first take a look at the issues with the current method of invoice financing and why there is a need for improvements.
Issues with modern invoice financing
Invoice financing sounds like a relatively simple process that offers clear benefits to both parties. But the current process of invoice financing also has its issues, such as:
- No standard invoice format
- Invoice verification is difficult
- Double spending
No standard invoice format
An invoice can be defined as a document that specifies when, who, and how much payment is due. However, there is no universal agreement on what information should be included in an invoice. E-invoicing presents a potential for standardisation, but even within this system, there is no set standard. This makes it difficult to securitise an invoice due to the potential for issues with the data and the operational processes surrounding the invoices.
Invoice verification is difficult
The second issue with current invoice financing is that verifying the validity of an invoice is very difficult. Before an invoice can be considered a secure title the financier will have to ensure that the debtor is able to fulfil their obligations as well as verify the correctness of all details in the invoice.
This also makes the financing of invoices inaccessible to regular investors. They do not possess the necessary means to conduct these thorough invoice verifications.
Another issue with invoices is that they tend to be unregistered in most areas. If somebody has malicious intentions they could sell the same invoice to multiple financiers. This is also difficult to detect for possible financiers.
How the tokenisation of invoices works
Let’s now take a look at how tokenisation and invoice financing work together is best explained using an example. Let’s take a look at the example below:
Company A sells a product to Company B and sends them an invoice to be paid within 90 days. They need the money from the invoice now and sell the invoice to a third party (financier) after the financier has done their due diligence in verifying the validity of the invoice. Company B then pays the invoice to the financier.
This is a simplified version of the current process of invoice financing. But let’s now take a more in-depth look at all the steps in this process and where the tokenisation comes in:
- Company A sells a product to Company B and sends an invoice to Company B to be paid within 90 days.
- Company A wants to use the money from the invoice now. It sells the invoice to a third party (financier) in order to get a percentage of the invoice value after the financier has performed their due diligence in assessing the invoice. The invoice is usually sold for 80-95% of the value of the invoice.
- The financier now holds the risk of that invoice on their balance sheet and they are required to hold capital for that risk. As these risks are high, the financier wants to distribute that risk.
- The financier tokenises the invoice and sells it to investors through an invoice market platform.
- When the payment term is due and the invoice is paid by Company B, the platform distributes the remainder of the invoice to the investors.
Benefits of invoice tokenisation and invoice markets
While the process with tokenised invoices and an invoice market is more complex than the current process, it can also address the various issues with the current process of invoice financing, in addition to offering various other benefits. The benefits of using tokenisation in invoice financing can be summarised as follows:
- Invoices as an asset class
- Standardisation of invoices
- More transparent ownership of invoices
- Increased efficiency and automation
Invoices as an asset class
As discussed, invoice financing is not accessible to general investors. The indicated is due to the amount of due diligence required when financing an invoice. By having a standard approach along with quality checks of the financiers, invoices can become an asset class that is highly accessible to regular investors.
This is a win-win situation for everyone involved. There is a bigger incentive for financiers to finance invoices as they have better and more efficient ways of managing their risk. It helps companies that want to sell their invoices as there will be a wider range of financiers. And lastly, it helps investors by giving them access to a new asset class.
Standardisation of invoices
In order to be able to become securities invoices will have to adhere to certain standards and quality checks. More comprehensive and complete invoices decrease risks and grey areas. Therefore the demand for higher prices, incentivising financiers to request a high standard of invoices.
Additionally, it might lead to better regulations surrounding invoice financing. It can help create a safer environment for financiers and investors alike as tokenised invoice financing becomes the norm.
More transparent ownership of invoices
Tokenised invoices are kept and tracked on a blockchain-based platform. This massively increases the transparency of ownership and ensures all parties have access to the same information. This increased transparency tackles the issue of double spending as ownership of invoices can be tracked more easily.
Increased transparency in the ownership of invoices can also help reduce the risk of errors with manual payments. This is done by providing clear and accurate information about who is responsible for the invoice and who is authorised to receive payment. With more visibility into the ownership of invoices, manual payment processes can be streamlined. Consequently, reducing the chance of miscommunication and mistakes.
Increased efficiency and automation
The last, but definitely not least important benefit of using tokenisation in invoice financing is increased efficiency and automation. With better invoice standards and an invoice market which increases transparency of invoice ownership and automates payouts to investors, the whole invoice financing process goes from a rather cumbersome manual process to a much more streamlined and automated process which benefits all parties involved.
Invoice financiers have an increased market to offset the risk of financed invoices, and in addition to that they no longer have to manage the tedious task of investor payouts when invoices are paid. For investors the process of investing in invoices also becomes much easier by having a transparent invoice market with a broad offering of invoices.
In conclusion, invoice financing and tokenisation of invoices provide a solution to various issues faced by companies and investors in accessing financing, managing risk, and ensuring the validity of invoices. Tokenisation offers greater transparency, standardisation, and automation in the financing process. This makes invoices a new and accessible asset class for regular investors. All, whilst providing efficient ways of managing risk for financiers. The use of tokenised invoices may also lead to better regulations surrounding invoice financing. Hence, this creates a safer environment for investors and financiers alike.
Parties like 2Tokens are also working on realising this use case in collaboration with a variety of parties.