Funding Import/Export Growth in the Super-Sized Economy
By Joseph Ingrassia and John Rice
Open the Flood Gates
Globalization and cross-border trade facilitated by regional free trade agreements and demand for low cost goods over the last 10 years have transitioned from a trickle to a flood. This has created great opportunity and has also displaced many workers in the U.S. economy. Knowledge workers have become part of the lexicon as more and more basic manufacturing has moved offshore where labor costs are extremely low.
According to The Wall Street Journal, during this period of time, manufacturing’s share of economic output fell from 18% to 14%. Today manufacturing in the United States is more focused on highly engineered products, high technology and precision manufacturing. Most developing economies/nations lack the expertise to compete with U.S. manufacturers in these areas of manufacturing. It will take another 10 years for foreign manufacturers to be competitive. This lag is related to their lack of engineering experience in these highly complex and technical areas of manufacturing. Combined with the relatively low value of the U.S. dollar, exports of these highly engineered and high tech products have increased dramatically, but they are still dwarfed by the demand U.S. consumers have for cheaply made foreign consumer goods. This trend has created vast wealth and liquidity in places like Russia, Eastern Europe, India, China, Cambodia, Vietnam and Thailand. South Korea and Singapore were once technology and financial centers and, because of their failure to react to globalization, they have been marginalized to some degree. Exports between South America and Asia have soared as the quest for raw materials needed for manufacturing becomes increasingly competitive.
The Changing Global Business Environment
In the United States it is often less expensive for consumers to purchase a replacement product for something that no longer works than to have it repaired, if they can find a repairman. This is a direct a result of globalization. To survive in the global marketplace, American manufacturers have had to invest in Asia to remain competitive. The investment could be in the form of a purchase of a state-owned enterprise or simply developing supply relationships for finished goods or labor-intensive components needed for assembly in the United States, South America or Europe. Consolidation of the retail sector and the industrial sector over the same period of time is a direct result of globalization and has a destabilizing effect on those businesses that support the supply chain, such as wholesalers, distributors, licensees, etc. in the United States. Back in the 80’s and 90’s, there used to be regional chains that had specific identities that supported the regional cultural differences the United States once had. Certain areas remain culturally unique, but that is more a function of activists limiting the march of international retail giants into their region. The Internet and globalization have reduced barriers that were once celebrated as making an area of the country or the world distinctive.
The evolving global business environment has changed the methods by which companies finance their operations and growth. The typical asset-based financing model does not necessarily work for most distribution companies anymore, since they have fewer assets than in the past. Just-in-time inventory management systems of the consolidated retail and industrial companies have changed the way most distributors operate their companies. In the past, they would purchase up to a 6-month supply of inventory. Now, they purchase based on the selling cycle and deliver to their customers as their customers advertise those same goods in circulars and by other promotional means or schedule production or construction. This means that asset-poor distributors must increasingly finance their giant retail and industrial customers.
With consolidation, the retailer or industrial company may owe through accounts receivable tens of millions of dollars to their distributor. The trade cycle has extended from 90 days to 180 days in most cases. Each day during the trade cycle, the distributor is receiving orders for more goods, which require more working capital. If the distributor had a typical asset-based line of credit, its lender would not be able to provide working capital to support the growth of the company during the extended trade cycle.
What are the distributor’s alternatives? One might be to negotiate extended trade terms with the supplier. This is often not feasible because of the cross-border nature of the relationship. Frequently, the supplier has a limit to the amount of credit it can provide to its U.S. customer. And if the U.S. importer does not pay as agreed, this creates more problems for both the distributor and the foreign manufacturer. The foreign manufacturer is unable to pay its local suppliers and must stop producing for the distributor, and the distributor can no longer count on timely deliveries from the foreign supplier, causing the distributor to slow its shipments down to its customer. The retailer or industrial company in this case must scramble to find other goods or cancel advertising or delay production because of late deliveries or failure to deliver on the part of the distributor. Since there are fewer retailers and industrial companies as a result of continuing consolidation, now more than ever, this is a death sentence for the distributor.
Funding Growth in a Super-Sized Economy
Many small distributors may do tens of millions of dollars a year in sales, but they are not attractive to equity investors because there is no real multiple return on the investment (ROI) required to capitalize them properly to effectively operate in the global economy. What does a distributor do when asset-based financing has its limitations in financing the company and equity investors are scarce? The only option is to seek out alternative or creative financing. This may come from family and friends, but this is highly unlikely, since a test order from Wal-Mart could be in the $4,000,000 range. And, if successful, it could be followed by several millions more in orders month after month, compounding the distributor’s problems. Factoring alone will not work in this situation, because the goods have to be accepted and delivered before a factor will buy the invoice. Factoring does not provide sufficient cash flow to fund the trade cycle and the distributor’s working capital requirements.
Venture merchant banking can be an effective solution to supply chain financing that enables its customers to grow in the range of 15% or more per year. Whether products are sourced domestically or internationally, a venture merchant bank can handle the freight and customs duties and then collect the accounts receivable on behalf of its clients. As a venture merchant bank serving the import/export community for more than 15 years, Capstone Business Credit has addressed many challenges within this space.
Across the globe, firms in the import/export business are utilizing such an integrated financing model that enables them to grow their distribution and focus on sales, not the need for working capital.
There are several steps in the process:
- Due Diligence: As with many financial processes, an in-depth review of the distributor’s business, products and customers is conducted. Once the venture merchant bank has analyzed the data, they close the transaction.
- Letters of Credit: The financing firm begins issuing letters of credit to the distributor’s suppliers. The suppliers are paid when they present documents to the financing firm’s bank, and the goods arrive shortly thereafter.
- Direction of Product: The financing firm works with the freight forwarder who clears the goods and directs them to a public warehouse.
- Advancement of Additional Funds: The financing firm advances additional funds to pay for duty, freight and clearance charges as these charges are incurred by the distributor.
- Creation of Accounts Receivable: Once the goods are shipped to the retailer or industrial company, the distributor creates an account receivable that the merchant bank will buy. The proceeds are used to settle the advance made by the financing firm through its letter of credit for the purchase of the goods, duties and freight expenses, and the balance is used as working capital for the client. The typical advance ranges between 80% and 85% of the invoice value.
- Self Liquidation: Then, 45 or 60 days later, when the account debtor pays the account receivable, the distributor receives the balance of invoice not advanced. Capstone, for example, is able to finance each trade as a distinct transaction that becomes a self-liquidating event.
Essentially, the merchant bank is purchasing pre-sold goods for the distributor, assuming they have been sold to creditworthy buyers. The distributor benefits from the financing platform with 100% leverage for the entire trade cycle and no longer has working capital issues. The focus on using sales or purchase orders allows the distributor to grow to become a successful, reliable supplier to its customers. The distributor is able to pay its freight forwarder and customs broker and take on ever increasing orders from retail or industrial customers without concern about the assets on its balance sheet. With bank or asset-based financing, the distributor would be limited by its credit line, and an increase would be warranted only if the distributor’s assets increased. A regular bank would not increase credit availability solely on purchase orders or sales orders.
Financial Innovation and Flexibility
The current super-sized economy is driving the need for flexible financing solutions that support firms with in-demand products. A firm’s balance sheet is no longer the sole criteria for working capital and financing options. Educate yourself about innovative financing options that support your firm’s growth, global positioning within the marketplace and business networking opportunities.
Joseph Ingrassia and John Rice are managing members of Capstone Business Credit, a venture merchant banking firm that has funded in excess of $1 billion in transactions. The firm provides working capital and structured financing to firms with typical sales of less than $100 million that are involved in the domestic and international trade of finished consumer and industrial products. The firm is headquartered in New York City, with offices in Beijing, China and the Cayman Islands. Please visit www.capstonetrade.com for more information, or call (212) 755-3636 (ext. 3444).
