We have seen two high-profile business failures recently – Greensill Capital and Football Index. It’s worth taking a peek under their bonnets.
Greensill Capital’s business model was as old as the hills – invoice factoring. Firm A supplies firm B with some goods. Payment terms are, at best, 30 days, and frequently longer. Often, firm A is a small company – think of a manufacturer making some engine widget for cars – and firm B is a large company – think Ford. B has all the bargaining power, A doesn’t have much cashflow, so B can make A wait for their money and A can struggle financially. Introduce an invoice factor company. They step into the middle. They immediately pay A the amount they are owed minus a fee, and then wait for B to pay them back.
This is pretty regular business. The invoice factor company gets paid a fee for two things: supplying the cash immediately, and taking on the credit risk of B. So what went wrong with Greensill? There are three possible factors.
Firstly, diversification is key. If 90% of the invoice factor company’s business is with a single firm and that firm gets into trouble then the business model falls apart. By the time Greensill ran into trouble, a large proportion of its business was allegedly with firms associated with the Gupta family –principally the steel business Liberty Company and other subsidiaries of its parent company, GFG Alliance.
Secondly, Greensill arranged insurance to cover the risk of the invoices not being paid, which improved the financial quality of the arrangements. There are allegations that this insurance wasn’t always properly arranged, and possibly more recently had been declined.
Thirdly, access to stable and long-term capital. The invoice factor company needs to have a constant supply of capital in order to pay firm A before it gets the money from firm B. Greensill got its capital by packaging up invoice deals and selling them on (a process called “securitisation”), typically to Credit Suisse. When Credit Suisse got nervous and balked at continuing this, Greensill’s supply of capital allegedly ran short.
Football Index was a trading market place for football players. Instead of trading shares of companies on the London Stock Exchange, users could trade football players. The better the footballers played, the higher their prices went. In addition, dividends were paid to “holders” of footballers – the better they played, the greater the dividends. Despite it marketing itself as a trading marketplace and an “investment opportunity”, Football Index was actually regulated as a gambling website.
Companies on the London Stock Exchange pay dividends from earnings the company has made. What was funding the dividends of footballers on Football Index? It’s uncertain, but it may have been new users coming onto the site. Eventually, those dividend payments were cut and then the whole operation was frozen as it ran out of money to make payments.
The common factor here is uncertain capital and sources of payments. Is that any different from a regular bank or building society model? They take deposits (in the form of current accounts, for example) which offer instant access, but then make loans (in the form of mortgages, for example) which are long-term commitments. If everyone who had a deposit demanded their money back instantly, then the bank or building society would be in trouble – see the film It’s a Wonderful Life(though best to wait until Christmas).
So how can we test the validity of a business model? One thought is to see what happens if the plates stop spinning i.e. if you freeze the business, will it end up solvent (even if it takes some time), or is it dependent on new business coming in all the time to support the old business?
A second thought is that 99% of good finance is dull. Invoice factoring should be a boring business. SoftBank, a technology firm, had invested $1.5bn into Greensill in2019. David Cameron was flying around the world on Greensill’s behalf on one of their four corporate jets. “Investment” websites should be regulated by the Financial Conduct Authority (FCA), not the Gambling Commission.
Method Asset Management provides our clients with good (but possibly dull) finance. History proves that long-term investment in a balanced portfolio of assets works. Our clients can then feel comfortable in a position that, when a “sexy opportunity” presents itself, they can make an informed decision whether they participate or not without giving themselves sleepless nights in the future.