How To Get Access To Working Capital Without Leaving Your Bank
The life of a small business is usually more about the journey than the destination. Initial objectives may seem straightforward, but the route is more often than not circuitous.
Cash flow is certainly one area of any business that remains dynamic. Lines of credit with traditional lenders can only take a business so far. Before long many SMEs hit their credit ceiling, which makes diversification or expansion difficult.
The search then begins for alternative/additional funding. Often the alternatives are not sufficiently differentiated to warrant the effort of unbundling your services from the incumbent funder.
You try and console yourself with the notion that at least you’re dealing with the “devil you know,” but you know at heart this is a compromise.
What you really need is a third party provider that won’t rock the boat with your bank and provide services that will help you grow your business, (which would seem as likely as Scarlett Johansson agreeing to a date with Warwick Capper.) The problem is that such a solution cannot be provided by a bank or in fact any financier that is backed by a traditional funder because of “process.”
The products have to stay between the marked lines. There’s usually even demarcation between products within each individual banking institution. The concept of building products that can be meshed with another financial provider’s services would defeat the purpose – like trying to put the brake pads of a Hyundai Lantra into a BMW M3 – it ain’t just gonna happen… but then again!
AR was recently approached by a client that had what might be termed a satisfactory (if not limited) relationship with their bank. Sound familiar? Their line of credit was stretched to the point that no more cash could be leveraged from the bank. Fate being what it is, they landed several contracts with a credit worthy clients (small business and good timing it seems, rarely share the same bed.)
Part of the contract stipulated the import of purpose-built materials. Add to this the standard additional fixed and variable costs associated with fulfilling any contract – i.e., wages, super, insurance, equipment hire, legal and administrative costs, and the game looked to be over before it had even kicked off.
The first problem to overcome was collateral security. The second was how to connect the client, their key supplier and the body issuing the contract in a transaction that would meet the needs of each organization through a third-party financial institution – something supplier chain financiers tout but usually on strictly limited terms.-The third, (as mooted above) was to ensure that the client’s relationship with its bank remained stable.
The solution involved a pollination of two products. To get the ball rolling, Purchase Order Finance was used to cover the costs of buying and shipping the materials (as specified in the contract) from an overseas manufacturer. On receipt of the PO, AR provided 80% of the funding within 24 hours. The remaining 20% was remitted when the end client paid (in this case 30 days later).
Project Finance was then used to secure the contract. This is where the credit worthiness of the client, i.e. the contract itself, becomes the collateral security instead of fixed or floating assets. This situation suited all parties. When works were completed to a satisfactory level, AR’s client would submit a claim to its customer. On approval, AR would issue the client 80% of the amount claimed within 1-2 days, remitting the remainder upon actual payment by the end-client.
This cycle continues until the contract is completed. At which point, the client no longer has any financial obligation to AR. In short there’s no lock-in as there would be with a traditional line of credit.
So when the best time to use this type of financing and what is is the best approach?