Last week, payroll platform Gusto began offering a service to provide its customers’ employees with other financial products. We are not going to get into details about that program, Ben Thompson will probably cover it better than we can, but this reminded us of a topic near and dear to our hearts – ways that companies can monetize their data beyond their actual product offering.

In particular, for years we have been pitching a similar idea to accounting software companies. There are dozens of these companies out there today helping companies track the usual litany of financial transactions. For our purposes, the most interesting piece of this is working capital – inventory, accounts payable and accounts receivable. There is an immense amount of data here and it could be worth a fortune to the accounting software provider willing to spend a little bit of effort.

The opportunity is fairly straightforward. Small companies sell products and services to big companies, but the big companies take their time to pay their suppliers. Payment terms can range from 7 days to 90 days, and sometimes longer. For many companies, especially smaller ones, this payment period can mean lean times. What if there was some way to get paid on day of delivery?

This is where the accounting software companies come into play. They can ‘see’ the entire financial transaction and history of payments. They know how long suppliers take to pay and crucially they know how reliable that payment schedule is. Large companies tend to be highly reliable in their payments, it may take them a while to process payments, but they (almost) always pay.

That information is what we can call a ‘risk model’. The accounting software company can use this model to offer credit. They pay the supplier a discounted amount of the receivable, say 95% (a purely illustrative number). The supplier is happy because they get paid much sooner and can pay their own suppliers and employees, and then go out and do more business. The customer is theoretically ambivalent, there is no change to their behavior, so they do not really care. The software middleman takes payment when the customer pays, and since they have access to the suppliers bank accounts they can slip themselves into the payment stream, and crucially they get to capture that 5% (again, an illustrative number) for doing almost nothing.

The accounting software company is capturing an arbitrage opportunity in the payment terms, a great source of profit. Admittedly, they do take the risk that the supplier does not pay, and this is where the risk model comes into play. They will often have years of payment history and can trust with some degree of certainty that they will get paid. They can also choose to not finance deals with suppliers whose payment terms are variable, and they probably need some credit monitoring service to make sure the customer is not teetering on the verge of bankruptcy. This is not zero risk, but it is very low risk, and the accounting software company has a tremendous amount of data to back this up.

This type of transaction is not new, in fact it is incredibly old, probably one of the oldest financial products around. This is basically what we call factoring, a service traditionally used by exporters, but it has new legs in a digital world. And there are plenty of different types of companies doing this in other fields. We use the example of accounting software, but investors like Pollen does something very similar with gaming companies.

The practicalities of getting such a program up and running are a bit more complicated. The average SaaS company does not have millions of dollars on its balance sheet, and arguably it should be using those funds for growing the core business.

Instead, we suggest companies work with an outside financial institution. First, to be clear, we do not mean a bank. Do NOT approach a bank with this, they will wrap it in paperwork, commitment committees, and analysis paralysis for years. Instead, the software company needs to find a hedge fund or other non-traditional (aka shadow banking) entity. There are literally hundreds of these funds out there.

Now these funds will be demanding. They will likely ask for a lot of the economics, but deals can be structured that will still leave plenty of profit for the software company. More important is that outside funding sources will not want to invest in a single deal. They have minimum investment amounts, and more to the point, they will want to invest in a portfolio of these payable streams to reduce overall risk. So the software company will need to string together dozens (or more) payment streams into some sort of corporate vehicle.

Part of the appeal of this for the software company is that the overall amount of investment required is very small. Aside from lawyers fees and management time, the only real requirement is having a data scientist on board who can create the statistical analysis around the company’s data. You will need someone to create the risk model and then convince the outside investors that it works. Chances are the investors will want to get their hands on anonymized data themselves and pull it apart, but the company needs to have someone who knows the data at a very deep level.

This can be incredibly lucrative. Even small accounting software companies we have worked sit on top of payables streams measured in billions of dollars. A few percentage points of that, can add meaningfully to the company’s bottom line, potentially reducing the need for future venture funding entirely.

We are greatly simplifying this. The process of building such an offering is daunting, and requires a lot of management time and mental exhaustion. It is also very far from most companies’ core competencies. And a lot of our work on these projects revolves around finding the right partners. Dealing with Wall Street investors can be fraught. But that is also part of the appeal. There is a giant ocean of money circling the world right now looking for returns. The cultural divide between Wall Street and the Valley is still large, and few start-ups we know ever even think about these Fixed Income and Structured Products markets, but we are certain that there are willing investors out there who will be interested in exploring this.

Photo credit: Dire Straits and Hipwallpaper