What is a Forward Flow Agreement?

A forward flow agreement, also known as a forward flow facility, is a type of financing arrangement that allows a company to sell its future accounts receivables to an investor in exchange for upfront capital. This provides the company with immediate access to capital based on the value of its future invoices.

In a forward flow agreement, the company sells a certain percentage of its future invoices to the investor at a discount. This allows the investor to earn a return by collecting the full face value of the invoices when they come due. Meanwhile, the company gets immediate cash to fund operations without taking on debt.

Elements of a Forward Flow Facility

There are several key elements and terms involved in setting up a forward flow agreement:

Advance Rate

The percentage of each invoice’s face value that the investor will pay upfront to the company. Typical advance rates range from 70-90%.

Discount Rate

The rate of interest charged by the investor on the advanced funds. Usually benchmarked to a rate like prime or LIBOR.

Facility Limit

The maximum amount the investor will advance over the course of the agreement. Usually a percentage of the company’s average monthly sales.

Tenor

The length of the agreement. Typically 6 months to 3 years. Can be revolving.

Concentration Limits

Caps on the percentage of invoices from any single customer that can be sold. Usually 5-20% of the total purchase.

Eligible Receivables

Requirements defining which of the company’s AR can be sold. Based on credit quality, age, concentration, etc.

Fees

In addition to the discount rate, there are often flat monthly fees and early termination fees.

Reporting Requirements

Requirements for the company to share sales reports, AR aging reports, compliance certificates, etc.

Advance Process

Here is an overview of the process to receive an advance once a forward flow agreement is in place:

  1. Company completes a sale to a customer and issues an invoice
  2. Company uploads invoice data to the investor’s online portal
  3. Investor verifies the invoice meets eligibility criteria
  4. Investor advances agreed percentage (advance rate) of the invoice value, less fees
  5. When customer pays the invoice, investor collects the full payment
  6. Investor returns any remaining balance, less fees, to the company

The process from invoice issuance to funding typically takes a few business days. Funding may be every week, every two weeks, or monthly depending on terms.

Benefits of Forward Flow Agreements

There are several potential benefits that make forward flow facilities attractive to companies:

Additionally, rates may improve over time as the investor becomes more comfortable with the risk of the company’s receivables.

Use of Funds

Forward flow agreements provide very flexible working capital since the advances are not tied to a specific use of funds. Typical uses include:

Funding day-to-day operations Hiring personnel Purchasing inventory and materials Investing in equipment upgrades Expanding marketing campaigns Entering new markets Funding new product development

Essentially, the capital can be deployed wherever it is needed most to grow the business.

Costs and Fees

There are a variety of fees associated with a forward flow facility. It’s important to take all costs into consideration when evaluating an offer. Common fees include:

The all-in cost of the facility needs to be analyzed relative to other financing options the company has available.

Eligibility of Receivables

In order to mitigate risk, investors have strict eligibility requirements governing which invoices they will agree to purchase:

Meeting eligibility criteria ensures the receivables align with the investor’s expected yield and default models.

Analyzing Forward Flow Economics

In order to determine if a forward flow agreement makes sense, companies should analyze the economic tradeoffs relative to alternative forms of financing. Important factors to model out include:

Running scenarios around retention percentage, turns per year, and implied APR can give key insights into the true cost. Thoroughly projecting the P&L impact is crucial.

Tax Implications

There can also be tax considerations to evaluate when monetizing future receivables:

Consulting the company’s accounting and tax advisors is highly recommended.

Structuring Details

Forward flow agreements involve complex legal structuring given the sale of future assets. Here are some key structuring considerations:

The contract terms matter greatly in an event of default such as bankruptcy. Companies should fully understand potential outcomes before signing.

Accounting Treatment

The specific accounting of forward flow agreements under U.S. GAAP or IFRS is very nuanced. From the seller perspective, key considerations include:

Application of standards like ASC 860 and IFRS 9 dictate balance sheet presentation and impacts the income statement.

Due Diligence Required

Given that forward flow facilities represent an outright sale of invoices, investors conduct very rigorous due diligence before approving a facility including:

This due diligence allows investors to gain comfort extending millions of dollars against unpredictable future sales.

Steps to Securing Forward Flow Financing

If a forward flow facility seems potentially suitable, here are key steps the company should take to pursue one:

  1. Analyze historical sales and accounts receivable data
  2. Review eligibility criteria from prospective financiers
  3. Evaluate economics under different scenarios
  4. Consult accounting advisor on proposed structure
  5. Partner with a financing broker to interface with funders
  6. Prepare due diligence documents for review
  7. Negotiate key facility terms
  8. Obtain board approval of final agreement
  9. Close, fund facility and conduct ongoing reporting

Having your internal records in order and leveraging an advisor to interface with capital providers simplifies the process while still protecting the company’s interests.

Pros and Cons

Some key benefits and drawbacks to weigh:

Pros:

Cons:

The pros and cons balance depends greatly on the specific business model and capital structure. The cost of forward flows should be compared to alternative facilities.

Recourse Factor Provisions

One specialized type of forward flow arrangement that limits a company’s financial risk is called a recourse factor provision. Under this structure:

  1. Company and funder establish concentration limits per customer
  2. Funder advances on all invoices up to limit
  3. If any invoice from customer defaults, company owes amount advanced on that specific invoice above limit
  4. Company has no obligation beyond specific defaulted invoice amounts

This protects the company by capping exposure to only a set level of advances per client. It incentivizes proper underwriting by the funder across their entire purchased portfolio.

Evaluation Process

Given the complexities and importance of properly structuring facilities, funders follow a highly standardized process including these key milestones:

This standardized funnel allows investors to systematically filter opportunities to ensure those ultimately approved meet their investment return hurdles.

Forward Flow in Fintech

Financial technology innovations are rapidly changing the forward flow industry. Key innovations include:

These trends will likely accelerate adoption while also compressing margins over the long-run. But in the near-term, technology provides a tailwind for the industry and companies utilizing these tools.

Comparison to Factoring

Forward flows have some high-level similarities but major differences from traditional invoice factoring which include:

So while factors provide fairly standardized products, forward flows give more control over deal terms but less volume adaptability.

Reporting Compliance

In order to track ongoing eligibility and signals around customer credit, forward flow agreements include extensive reporting requirements requiring companies to provide:

While most data can be provided digitally, site visits enable funders to physically validate company records and processes aligned with contracts.

Types of Facility Extensions

As forward flow contracts near maturity, companies seeking to renew agreements have several options including:

Broader economic conditions also play a role if tighter credit markets limit availability.

Covenants and Defaults

Forward flow agreements contain highly restrictive covenants requiring tight operating controls to avoid technical defaults including:

Proactively flagging tripwires with investors and having waivers drafted helps minimize interruptions to financing availability.

That covers the key elements around forward flow agreements and facilities. Let me know if you need any clarification or have additional questions!