What is an A/R put option?
Accounts Receivables (A/R) put options offer protection against financial loss due to customer bankruptcies. These contracts are similar to traditional “trade credit insurance” but with several key differences. For instance, A/R put options offer 100% protection (90% is typical with trade credit insurance); they offer non-cancellable coverage; and they offer coverage on single customers, often with larger limits than possible with traditional insurance. In addition to risk protection, our clients often find they can obtain financing on otherwise ineligible receivables after purchasing an A/R put option. Please see these case studies for some examples of how A/R put options might work for your company.
For companies trading on open account terms, even a single large customer default can cause insolvency. A/R put options can be an efficient way to sell with confidence and security. When reviewing the contracts, we encourage all suppliers to consult with legal and accounting advisers regarding local compliance.
An A/R put option:
- usually offers coverage from $100,000 to >$10,000,000 (depending on credit of buyer)
- generally covers invoice tenors of 30 days to 180 days
- provides coverage on U.S. (and some EU/UK) companies with publicly-traded debt, and sometimes on larger privately-held companies when audited financials can be made available for review
- offers non-cancellable coverage, which cannot be reduced or cancelled during the contract period, even if the buyer's credit quality deteriorates
- can be obtained on single customers – no need to include multiple customers in order to obtain coverage – cover only your riskier and larger buyers
- usually covers 100% of exposure up to the coverage limit, with no deductibles or co-insurance
- contractual counter-parties are banks, private equity firms, and other private sector financial firms
- can be implemented in as few as 3 days from non-bank lenders, or 1-2 weeks from banks
- covers buyer bankruptcy or financial default only
- generally has 'premium rates' which vary from 0.5% to several % per month, based on the covered amount
- does not notify your customer of this coverage in any way
- can be written to cover customers that are distressed or in Chapter 11
- is usually treated as insurance for accounting purposes and as such can be off-balance sheet and expensed under GAAP (always check with your local legal & financial advisors)
A/R put options are not as common as traditional A/R insurance because traditional A/R insurance is often a viable, cheaper alternative for covering customers without large default risk.
When you buy an A/R put option, you are buying the option of selling your A/R to a counterparty at a pre-established price within an agreed timeframe, if a pre-defined event occurs, such as customer bankruptcy. In other words, an A/R put option is a contingent A/R sale agreement for suppliers. Suppliers will buy an A/R put option in order to protect their sales, and/or qualify for A/R financing. The protection offered by an A/R put option is similar to that which you would find in a single-buyer credit insurance policy. The supplier sets the dollar amount at outset, usually from the expected credit balance with the customer.
This means that the coverage can be structured to protect you in the event that your supplier's insolvency causes you to incur unbudgeted financial exposure. If one of your largest customers defaulted, it might represent an enterprise risk for your company! Here at Export Safe, we're A/R put option experts - please contact us for information & quotes!