8 Red Flags To Know Before Investing In Invoice Discounting Platforms

KEY TAKEAWAYS

1. Invoice discounting platforms offer high returns but are unregulated in India, making them high-risk investments.

2. Key red flags include lack of transparency about directors, poor KYC checks, and platforms running under unrelated business names.

3. Frequent auditor changes, family-related deals, and legal lapses in agreements are significant warning signs.

4. Absence of escrow accounts and shaky financials further indicate potential risks and lack of transparency.

5. Investors should conduct thorough research and be aware of these red flags to avoid scams like the Rs 850 crore Falcon incident.

“RBI Kehta Hai, Jaankaar Baniye, Satark Rahiye”...I am sure most of you must have heard this during RBI’s consumer education and financial awareness campaigns in recent years, right? From cyber frauds, unknown links to scam calls, there are so many ways in which you can lose money nowadays if you are not careful.

Well, apart from these, there is one more way in which you can lose your hard-earned money - By getting enticed by the ‘too good to be true’ returns of up to 15%-18% being offered by invoice discounting platforms.

Just a few months ago, an invoice discounting platform named Falcon, which was offering up to 22% returns, had been caught in a Rs 850 crore scam, about which we, at ALT Investor, had already warned investors more than a year ago.

But before we dig into this segment of how to see the red flags of such invoice discounting platforms, let us just refresh your memory, or if need be, help you understand what the concept of invoice discounting actually is.

What Is Invoice Discounting?

Invoice discounting is a form of short-term borrowing in which a business can receive immediate cash by using its outstanding invoices/unpaid bills on delivered products, as collateral.

But you may wonder why do businesses do so? Well, they do this to quickly get cash for reasons such as:

• Pay their own suppliers and employees

• Pay for fulfilment of other orders

• Re-invest in the business to maintain growth momentum

Understanding Invoice Discounting With An Example

For example, a ‘company X‘ sold Rs 1 lakh worth of goods to Flipkart on May 5th, 2023, and they are expected to receive the payment in 60 days, i.e. by July 5th, 2023, as per Flipkart's payment cycle.

However, company X is currently facing a cash crunch as it needs to fulfil other ongoing orders, pay its own suppliers and also cover staff salaries. But the payment from Flipkart will take another 60 days, so to solve this cash crunch, company X approaches an invoice discounting platform to get finance against the Flipkart invoice.

The invoice discounting platform showcases this deal on its platform for a fixed rate of return. Investors check out the deal and collectively pool in Rs 90,000 and pay company X, who is satisfied with the arrangement. And then 60 days later, when Flipkart releases the payment to X, they repay the full Rs 1 lakh to investors in proportionate amounts against the Rs 90,000 they invested at a discounted rate against the Rs 1 lakh bill. This arrangement allows investors to earn some decent returns in a short period of time.

But what’s the catch here? Well, firstly, invoice discounting as an investment vehicle itself, is unregulated in India, which means it does not fall under the purview of SEBI or RBI, making it a high risk investment.

Check out this blog of ours to understand the various types of risks in invoice discounting.

List of Red Flags To Watch Out For

Here’s a list of some basic red flags you must identify before investing your hard earned money into any ‘lucrative’ deals on invoice discounting platforms.

1. No Public Info On Directors/Owners

   If a platform is offering very little transparency about who owns or manages it, chances are high that things may be shady. Also, if the company does not disclose the previous and current directors' backgrounds, they do not seem to be verifiable, and there is lack of any professionals overseeing risk or compliance functions within the company, then these are notable red flags too, which you should not ignore.

2. Poor KYC Checks

   If the KYC process of any platform is being easily bypassed, incorrect or blank identification documents are being accepted and at worst automatically approved, then it indicates no real verification, which is a big red flag as an investor or user.

3. Running In The Name Of An Unrelated Business

   Similar to what we red flagged about Falcon Invoice Discounting Platform (much before its scam leaked out this year), if an invoice discounting platform is legally registered as some other business which is totally unrelated to what its core business (in this invoice discounting), then this can be treated as red flag, because this is a violation of the MoA (Memorandum of Association) and is termed as outside the legal boundaries.

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   Note: The Memorandum of Association (MoA) is a key legal document that defines the constitution, purpose, and scope of activities of a company. It mentions information such as the company’s name and registered office, permitted business activities, liability of members, etc.

4. Sudden & Frequent Auditor Changes

   If a company has changed its appointed auditor suddenly, and more so, frequently in the past months/years, or the auditors have themselves resigned, then the company’s books might be having something fishy.

5. Family-Related Deals

   In case the platform is showing many investment opportunities which are closely connected to companies owned by the same members/family, then these can raise concerns about conflict of interest and lack of due diligence, especially if such relationships are undisclosed to investors.

6. Lots Of Legal Lapses In Agreements

   Another red flag can be in the form of poorly written investment agreements, including legal inconsistencies, usage of unauthorized logos, lack of stamp paper, etc, which can make them unlikely to hold up in court. The risk of fraud can also rise in such cases.

7. No Escrow Account Details

   In one of our previous blogs, we had clearly explained the importance of escrow accounts in financial transactions. So, if an invoice discounting platform is depositing investors’ money directly into the company’s regular bank account instead of a designated escrow account, then investors would have no legal claim if the company becomes insolvent, which is a sign of zero transparency as well regarding how your deposited money is being utilized. This can expose serious operational risks and the lack of right intention pertaining to the company. We had highlighted this issue of escrow accounts’ absence a couple of times when we red flagged Falcon and WO Trades, both being invoice discounting platforms, which you can check out by clicking on the respective blog links.

8. Shaky Financials

   If the platform’s financials don’t seem solid enough, with signals such as consistently negative cashflow, rising debt levels, declining revenue, frequent changes in accounting policies and delayed financial reporting, then this can be considered a red flag too, besides becoming the reason behind a number of risks such as credit risk or liquidity risk.

Conclusion

It’s a no-brainer that invoice discounting is a high risk product, primarily because of its unregulated nature. Add to it the possibility of earning some quick bucks through high returns within a short period of time, and it becomes an ‘enticing’ investment instrument for many, right?

But that is exactly where you, as an investor, should remember all the red flags that we have highlighted, and should apply your own research and risk analysis or at best, and if need be, reach out to a trustable financial advisor.

Note that, while some invoice discounting platforms may be transparent enough to share invoice data, copies of goods delivered receipts, and other financial data, but most platforms in this segment, don't, which makes it very difficult to assess the risk of a platform and investment opportunity. After all, the Rs 850 crore scam by Falcon invoice discounting platform in itself has been an eye-opener, hasn’t it?

Please note that this is an opinion blog and not an official research or investment advice*. This blog aims to help retail investors make an informed decision when thinking of making investments. The blog neither encourages nor discourages you from investing in any particular platform or property or any asset class.*

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