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Contract Finance
Alongside invoice finance and PO finance, contract finance provides a way for businesses to gain capital and smooth cash flow in the early stages of a project, through a loan secured against the contract and the client’s creditworthiness. At Clifton Private Finance, we can help you structure both lump sum loans and revolving credit facilities that use contracts as securities.
Specialist Contract-Based Lending
Many businesses find themselves in the situation where they need capital investment to provide the resources necessary to fulfil a significant contract. The opportunity for growth provided by the contract is often significant, but a catch-22 situation can present itself: you need the money to invest in resources to get the work done - salaries, equipment, research, or more - but won’t see any income from the job until it’s complete.
If your company is not in a position to secure traditional funding, it can seem frustrating and unfair - you know the money will come, if you can just get the capital to undertake the project. Contract finance provides the answer.
Contract finance is funding that uses the contract itself as an intangible asset in much the same way that traditional invoice finance uses accounts receivable, or PO finance uses a binding purchase order. While traditional banks lean towards physical assets to secure finance, specialist lenders understand the fast-moving pace of service-based businesses, offering tailored contract-based solutions to meet this niche requirement.
At Clifton Private Finance, we work with these lenders, opening the door for our clients to secure the funding they need for unhindered, well-managed growth.
The Contract / Cash Flow Gap
The real world situation that many project-based businesses face is that there can be a substantial delay between a project’s agreement and its first invoice payment. This can create a strain on cash flow that requires a capital injection to relieve.
Often, company directors fear that to be transparent about this challenge would risk the contract itself, showing their enterprise up as ‘too small’ to be able to handle the new project. They may perceive that the client is expecting smooth professionalism, not a request to provide scaffolding to hold up the early stages of the project. For this reason, directors may shy away from asking for an early release of funds. Even when a staged payment is appropriate - for example, a 25% payment up front - the client’s invoicing terms can create a secondary bottleneck.
Consider this illustrative example:
ABCD Software Solutions Ltd. pitches for a £1 million deal from XYZ Building Management Co. For ABCD, the project represents a true leap forward, offering security and growth, and putting them on a larger stage for future contracts. They have worked hard to make their presentation and when they are selected to be the main software supplier, they are overjoyed.
The payment structure for the project has been defined by the client as a 10% signing deposit, followed by three staged payments of 30% to come at defined checkpoints. The first of these checkpoints is expected to be reached at the end of month three.
ABCD immediately issue an invoice for the first 10% (£100,000). This is on 30 day terms, but with the payment schedule of the large client, ABCD has been warned it may not truly be cleared funds until the end of month two. They cannot rely on it to meet their initial expenses.
The options they explore are:
- Unsecured finance - Considering the size and age of their business, ABCD would be unable to obtain unsecured finance for the size needed. Additionally, the rates would be extremely high, making it a very expensive option.
- Traditional secured finance - With no tangible assets (property, high-value machinery, etc.), ABCD are not in a position to obtain a secured loan from a high-street bank.
- Invoice finance - With a £100,000 invoice in their accounts receivable, ABCD could use invoice finance to speed up the money, however, it would only provide around £80,000, leaving them a significant shortfall.
As it stands, ABCD has a problem - it has a signed contract for a sizeable sum, but cannot invest, and if the directors move forward with their plan to hire new staff, will very quickly face a cash flow and payroll disaster.
Thankfully, contract finance provides the power that invoice finance alone cannot offer. Rather than leveraging the existing invoice, which only represents 10% of the contract’s full value, a lender offering contract finance will recognise the full expected income from the whole project: £1,000,000.
Contract Finance, PO Finance, and Invoice Finance
Contract finance is a specialised short-term funding solution that is positioned alongside PO finance and invoice finance as products to support business cash flow when future income is guaranteed but investment is required. They each have their part to play in the toolbox of business finance, and have subtle but important distinctions:
Receivables Finance
|
Type |
Security |
Timing |
Use |
|
Purchase Order (PO) Finance |
Confirmed purchase order |
Before goods / services are supplied |
Used by manufacturers, importers, and suppliers needing to obtain materials or stock to fund production or fulfil an order. |
|
Contract Finance |
Signed service contract |
Before or during project |
Lump sum loan for service-based businesses to obtain the working capital needed to deliver high-value contracts. |
|
Invoice Finance |
Accounts receivable (raised invoices) |
After delivery, before payment |
Provided to businesses needing to expedite invoice payments. Often also set up as a revolving credit facility for long-term use. |
The choice between these three similar cash flow support products is subtle but important, with each servicing a specific need in B2B transactions. Other options, such as dynamic discounting can also provide support for the supplier, ensuring that the funds are available when needed.
How Contracts Form an Asset for Security
Not every contract can be used to secure a loan. Lenders are looking for assurance that the money is guaranteed by establishing that the future income is real and reliable. Providers exercise due diligence to establish a risk profile for the finance and will assess:
- The end client’s creditworthiness - Contract finance is leveraged based on the security that the client will make good on their promise to pay for the services, so their financial status will form a core part of the underwriting.
- The contract terms - The details of the contract, including its payment schedule and cancellation clauses will be considered.
- Your ability to deliver the project - The lender will want to be assured that your business is in a position to realistically undertake the work detailed by the contract. In most cases, this merely parallels the due diligence the client will have performed before awarding the contract.
When the contract is with a reputable client - for example, public sector institutions, large corporations, and other well-established organisations - the risk profile is lower, resulting in a greater potential for funding. Smaller clients and unknowns may undergo additional scrutiny. In some cases, this makes contract finance transparent, as financial details of the end client are requested as part of the underwriting process.
The lender may also enforce an assignment of proceeds, a legal agreement whereby the client invoice payments go to a controlled account. Money is released to you only once the appropriate repayment has been made directly to the lender.
Personal director’s guarantees are also common to further lower lender risk.
Contract Finance in Detail
Working with Clifton Private Finance means you will have a partner onside to help smooth the process. We work with a range of dedicated lenders specialised in tailoring contract-leveraged capital with a structure suited to your exact needs.
Step 1 - Application and Review
Your business advisor will work with you to collate the necessary information. Your client details and copies of signed contracts will form the core of the application package to be presented to lenders. As a whole of market broker, we have access to the full range of specialist providers offering contract finance and will match you to those who are a best fit for flexibility, efficiency, and rate.
The lender will review the contract details before making an offer for finance with an LTV and rate based on the assessed risk. Many contract finance deals range from 30% to 50% of the full contract turnover, though agreements reaching as much as 80% LTV may be possible based on circumstances and underwriting.
Step 2 - Structuring the Contract Finance
The majority of contract finance funding is structured as a simple lump sum advance, providing the capital needed to invest in your business to undertake the project. Other options however, do exist:
- Drawdown facility- Staged payments that are tied to milestones or released over time to aid cashflow. Drawdown benefits by minimising interest on unused capital, but typically has a slightly higher rate than a single lump sum.
- Revolving credit facility - For businesses with multiple contracts and a need for repeated finance, a revolving line of credit can be set up. With this, new contracts can be added to the facility as they are signed, with an upper credit level to match.
Step 3 - Repayment
Repayments are made along agreed timeframes, as you invoice the client at the specified and pre-agreed milestones. In many cases, these will be repaid directly to the lender’s account as part of the assignment of proceeds, or they may be paid to you with the understanding that an immediate repayment is made to the facility.
In the case of a lump sum or drawdown facility, these payments will reduce the balance. A revolving credit facility will be replenished accordingly, with new credit being made available. In all cases, interest and fees are added to the loan balance. These are either rolled-up or serviced monthly.
Who Contract Finance is For
Some industries where contract finance is a powerful and efficient tool include:
- IT and technology services - With long-term contracts serving reliable clients, technology service companies are perfectly placed to gain value from contract finance.
- Creative and marketing agencies - Typically asset-light, solid contracts for creatives from reputable clients provide viable security.
- Recruitment companies - With recurring placement fees for large clients, revolving credit facilities help smooth cash flow.
- Construction subcontractors - Traditionally smaller businesses working for well-established firms, construction companies potentially have the collateral needed for valuable funding.
Facilities management - Supplying essential services to customers with expansive property portfolios means facility management providers offer lenders strong creditworthiness.
Contract Finance with Clifton Private Finance
At CPF, we’re dedicated to helping your business at every stage of its growth. Contract finance is one of many tools that can give you the freedom and financial backing you need to expand comfortably and effectively, smoothing cash flow and providing the capital you need to ensure your business is ready for the larger scale projects on the horizon.
Our advisors are seasoned experts who will consider your business needs in a comprehensive manner, forming a thorough overview of your funding requirements so that we can match you to the right lenders and the right products to best serve your needs. As a whole-of-market broker, we have the relationships in place to introduce you to lenders with a proper understanding of your industry and its unique challenges, resulting in finance solutions tailored precisely to suit.
Contact CPF today for a free consultation and seize the opportunities that bigger, more lucrative contracts offer.
