4 key advantages of Invoice Discounting over Bank Overdrafts

1. Property Security

Most Bank Overdrafts will require some form of property as security – either commercial property or personal property. Because most small businesses will not hold a freehold commercial property, Banks will seek security over the personal property of the one or more of the Directors. This means of course that if the business itself becomes unable to service or repay the overdraft, the Directors personal property may be pursued to repay the overdraft.

Invoice Discounting advances are not secured by personal property assets, rather are backed by the value of debtor invoice(s) and therefore the business only. This approach allows Directors to preserve the separation between their business and personal interests.

2. Restrictive covenants

A Bank Overdraft will usually require the business to agree to a series of covenants (or undertakings) as part of the overdraft agreement. In the event that a covenant is broken, the Bank will have the right to demand immediate repayment of the overdraft.

Common covenants include restrictions on business profitability, turnover, debt levels and distributions (ie dividends). Monthly compliance reporting will also be required.

Invoice Discounting advances do not require covenant undertakings or regular compliance reporting. Rather, a straightforward facility agreement is used for all transactions.

3. Overdraft Limit

A Bank Overdraft will have a specific limit which is fixed. Increasing or modifying an overdraft limit requires a new application, which is time consuming and costly. The major downside of a fixed limit is that the overdraft does not scale with the business, and may become unsuited to the needs of the business over time.

Invoice Discounting advances are determined by the value of invoices, so as a business grows, so too will outstanding invoices and the funding that can be advanced. In this way Invoice Discount funding scales with the business, rather than remaining fixed.

4. Fees and Charges

Bank Overdrafts include a variety of fees and charges in addition to the interest rate itself. These can include Application fees (becoming less common), Monthly Account fees and Overdraft Limit fees. In total fees can add several percentage points to the overall cost of a facility.

Invoice Discounting advances often do not include any fees and charges in addition to the advance rate.

Comparing the alternatives

Invoice Discounting advances are straightforward to understand and establish, quick to execute and transparent. For this reason they are often used as an alternative to Bank Overdrafts and in particular they have the significant advantages of not tying up residential property or the business with security obligations and restrictive covenants.