Credit and Finance for MSMEs: Jaipur-based third-generation entrepreneur Ravi Modani had just completed his masters in commerce from the University of Rajasthan in 1992 when one of his highly working capital-intensive family businesses of manufacturing laundry soaps — Hansa Soaps went bankrupt and got shut. The reason for failure wasn’t high competition or lack of innovation but inadequate working capital to continue the business operations. The company “lost all money because of mismanagement of long term and short term funds,” he recalled as banks also shied away from helping recover the business. While his family continued with the other business of jute rope manufacturing called Hansa Rope Industries, Modani pursued his doctorate from the same university in working capital management partly to probe deeper into the mistakes they made and rationalise the loss of his family business.
Before he eventually put his PhD into practice and get into the unorganised working capital space, Modani ventured into producing and exporting Silica-based minerals in 1999 to 28 countries across the globe under his first company RSP Corporation. 11 years later, in 2010, he bought a South African PVC pipes manufacturing company Radiant Corporation that had turned sick due to liquidity issues amid delayed payments from its customers. Looking for credit from banks in South Africa to revive the business, Modani came across factoring as a model to unlock money tied up in unpaid invoices. (from the sick unit’s customers. Was payment delay the reason for that company becoming defunct?). This was his eureka moment to replicate the model in India since factoring was almost non-existent here.
However, it took Modani good five years to start the non-banking financial company (NBFC) 121 Finance in 2015. “It took that much time to turn around the South African company, but I was tired of travelling every week to-and-fro India. Moreover, finance was one of my areas of interest. So, the reasons for selling that business were to explore opportunities in the financing space, stay more with my family, travel less, and focus more on RSP which is still our bread and butter. Since I already had the idea of a factoring business, I launched 121 Finance,” said Modani.
For the first seven years, the company was pure-play into lending to enterprises and proprietary firms. In January 2022 the Reserve Bank of India (RBI) issued regulations for the amended Factoring Regulation Act, 2011 after the Parliament had passed the Factoring Regulation (amendment) Bill in July 2021 that made eligible “as many as 9,000 NBFCs to participate in the factoring market, instead of just seven now, boosting cash flow to small businesses,” Finance Minister Nirmala Sitharaman had said speaking on the bill in Rajya Sabha in July. The amendment had removed earlier guidelines that allowed NBFCs to remain in factoring business only if their financial assets in the factoring arm and income earned from it was over 50 per cent of the company’s gross assets and net income.
121 Finance last month became the first NBFC-Factor in India post revised regulations with the Certificate of Registration under Registration of Factors (Reserve Bank) Regulations, 2022. Overall, it was the eighth NBFC-Factor in India eligible to undertake the factoring model.
For more than a decade in India, factoring was done by seven NBFC-Factors including subsidiaries of large public lenders such as Canara Bank, SBI and private entities including India Factoring, Siemens Factoring, and more. Every company seeking to register as an NBFC-Factor required a minimum net owned fund (NOF) of Rs 5 crore. Other than NBFC-Factors, banks have been allowed to do factoring business in India. In other words, any lending company, other than a bank, could not enter into factoring unless it was registered as NBFC-Factor.
However, banks and NBFC-Factors have traditionally been more inclined towards offering factoring services to corporates, who want to discount their invoices, instead of MSMEs, said Modani. “Even today you will see factoring happening for as high as Rs 200 crore transaction. Mass market factoring or for small businesses has been severely lacking due to low ticket size and factors not being sure about recovering money from MSME’s debtor,” he said.
On the other hand, the RBI-registered TReDS platform, which offers factoring for MSMEs to discount their invoices, is eligible for MSMEs’ buyers with a turnover of Rs 500 crore or more. “Where would MSMEs go for factoring if their buyer’s turnover is less than Rs 500 crore? The number of such MSMEs is huge. This is where we fit in. We have factored invoices as low as Rs 27 for MSMEs. Moreover, due to the turnover threshold on TReDS, MSMEs cannot register themselves as buyers in case their sellers want to get their invoices factored,” said Modani. 121 Finance allows MSMEs and corporates to onboard its platform as both buyers and sellers of invoices.
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Factoring, as a process, which is akin to the bill or invoice discounting mechanism, essentially involves a seller (MSME) selling its invoices (dues from its government or corporate buyer) to a third-party financier called factor (banks or NBFC-Factors) for immediate disbursal of up to 70-80 per cent of the invoice value to the seller towards his/her working capital requirement. The factor then undertakes the payment collection process from the buyer. After collecting the outstanding payment, the factor pays the balance amount to the seller after deducting a fee. 121 Finance takes a cut of Rs 5 to Rs 250 as per the invoice size.
In comparison, financiers in the invoice discounting model disburse the percentage of invoice value as a loan to the seller and pay the balance amount minus the fee after the seller receives the payment from the buyer. The onus to collect payments from buyers is generally on the seller.
“The money you take from financier is still an unsecured loan on your balance sheet while in factoring (recourse and non-recourse) you are transferring the entire thing from your book to the factor which is a huge advantage to any seller or MSME,” said Modani. In non-recourse factoring, the factor undertakes the risk of non-payment from buyers while in recourse factoring, the risk is partially or fully undertaken by the seller who has to return the advance to the financier in case the buyer defaults. The recourse factoring fee is usually around 1 per cent or less but goes up to around 3 per cent in the case of non-recourse factoring. 121 Finance and TReDS offer non-recourse factoring.
“The reason the government has made it non-recourse is that even if it is recourse factoring, MSMEs won’t be in a position to pay back the amount. Non-recourse encourages MSMEs to take the factoring route,” said Modani.
Beyond factoring, 121 Finance has been offering Buy Now Pay Later services, cash-flow based working capital finance, and co-lending as well. The typical turnover size of MSMEs coming for factoring on the platform is Rs 50 lakh to Rs 2 crore. 121 Finance is currently disbursing Rs 30 crore in nearly 2,000 transactions per month under factoring and is expecting to close the first financial year (FY23) in factoring with up to Rs 500 crore disbursement in 3,500 transactions approximately.