SPECIALTY LENDING: MODERN PURCHASE ORDER FINANCE OFFERS FLEXIBILITY TO SUPPLEMENT TRADITIONAL LENDING METHODS
Although purchase order finance is not a new product, many traditional lenders do not realize that it has changed with the times and offers new options. Edward King explains how PO finance companies can partner with lenders to create innovative solutions for borrowers.
BY EDWARD KING
Purchase order financing is a form of specialty finance that has become more widely recognized in recent years. However, the value of the PO finance solution is still not completely understood.
When I started in PO finance 27 years ago, I had to thoroughly explain what we did to every person I spoke with, because the concept was rather new, and we were still developing the product ourselves. We needed to educate not only our lender partners but all our prospective clients because very few lenders and companies knew about the benefit of utilizing or partnering with a PO finance company.
Fast forward to today. The term PO or purchase order finance is well known but many people still don’t truly understand the breadth and value of PO finance solutions, since our solutions continually evolve to help companies grow in this modern ever-changing world.
There are many different variations of PO finance, and almost every month we consider changes to help provide new PO finance solutions that help with new business models and customer needs. Unfortunately even though the term “PO” and “purchase order finance” is better known today, the vast majority of traditional lenders and asset-based lenders still view it through the lens of the past. PO finance is not just finished goods financing for defined deliveries.
Not Your Father’s PO Finance
Today’s purchase order finance is a very broad offering for good companies that don’t have the balance sheet to support their pre-delivery working capital needs to fulfill orders to credit-worthy end customers.
PO finance is performance risk financing, not traditional asset-based or balance sheet financing. When a PO finance company initially funds its client, the assets or inventory do not yet exist. A purchase order is not an asset — it is simply an indication of interest from a customer to make a purchase under certain terms if the company can deliver.
A true purchase order finance solution provider is willing to take the full delivery risk. This includes the manufacture, delivery, and acceptance of goods and services to help a company grow their sales, even when the capital needs far exceeds its traditional collateral.
A common misconception is that PO’s are non-cancellable and therefore, low risk. This assumption is a mistake made by many traditional and asset-based lenders. Purchase orders and customer vendor agreements make virtually every purchase order cancellable for almost any reason. If a PO financing is not structured or monitored properly, a lender can lose a significant amount of money on one cancelled delivery.
Due to the many risks of performance and cancellation of POs, financing the inventory to fulfill orders is an art, not a science, and should be handled in an experienced, disciplined manner. By utilizing a PO finance source with years of experience and institutional knowledge of how to structure and monitor the PO financing properly, a businesses can grow their sales and profits successfully unencumbered by traditional ABL balance sheet constraints.
An established PO finance company can bring a great deal of value to factors, asset-based lenders and banks. A PO finance company working in conjunction with a traditional lender offers its customers additional liquidity to help them grow sales and profits beyond their current balance sheet or asset-based formula. PO finance companies help and compliment traditional lenders and their customers by increasing sales and profits without the lender taking on additional risk outside their finance formula.
Partnering with Traditional Lenders
PO financiers can also benefit their lending partners in other ways. First, they provide capital to grow sales for the customer, offering more financing availability for the senior lender. Second, a PO lender keeps a watchful eye on the inventory being manufactured and/or delivered to the end customers. The lenders are protected by the PO company’s monitoring of the quantity and quality of the inventory, along with following the shipping and delivery logistics until the purchase orders are successfully fulfilled and the receivables created. PO monitoring offers assurances that a traditional lender often doesn’t have in their typical finance relationships.
Typically, a PO finance company takes the performance risk to finance the capital needed to fund the pre-delivery costs of fulfilling orders. The PO company finances the goods to fulfill the orders. The factor or ABL then advances on the receivables or inventory once the traditional collateral is created, paying off the cost of goods to the PO finance company.
This complimentary relationship is a great benefit to the customer since each finance partner is an expert at what it does, and the customer is getting the best offering of PO finance and help from their bank, ABL, or factor. Neither finance party is being asked to do anything they aren’t comfortable with; they are simply working together to offer the customer additional liquidity to help grow profits.
An example of a relationship between a PO finance company and its friends in the traditional finance world would be a situation where an existing client of a factor, ABL or bank establishes a new customer relationship. The client’s current sales are financed under the present asset-based formula but with this new end customer relationship, the client is going to need capital well in excess of what its balance sheet will support. The opportunity is great for the business, but it needs a solution to help finance the increased inventory acquisition to fulfill the larger orders.
The ABL lender wants to help, but the orders are much larger than the asset base so the lender reaches out to a PO finance company to discuss its client and the need for PO financing. The PO company can quickly assess the finance solution to allow the customer to acquire the inventory needed to fill the much larger orders. The PO company then enters into a PO relationship with the client as well as a complimentary inter-creditor relationship with the senior lender to provide PO financing in conjunction with their financing. PO financing will help the company finance the purchase or manufacture of the goods needed to fill the larger orders, and once the sales are invoiced, the customer borrows against their collateral or factors their receivables to pay down the PO finance facility. This can happen on a spot basis or repeated basis all year long until the company’s balance sheet grows to the point that the traditional lender is able to once again provide sufficient liquidity for the higher sales volumes.
The end result of partnering with a PO finance lender is increased sales and profits for the client leading to increased finance volumes for the traditional lenders. •