A major change has happened recently in trade finance that now allows a whole new sector in the supply chain to get access to funding. That sector is the manufacturing industry.
It has long been known in the trade finance game that lenders in this arena will usually only fund the purchase of stock as finished goods e.g. they will fund the purchase of a batch of watches, but not fund the purchase of the components to make the watch. However, there is now one or two private funders who will fund the purchase of raw materials, and fund quite large sums too.
What this historically meant was that the only parts of the supply chain that could access trade finance were those firms buying and selling the finished good further down the line. So those sectors were wholesalers, importers, exporters, distributors and retailers. What the recent changes have meant is that manufacturers, one step back in the supply chain process, can now access similar types of funding.
Why only Finished Goods?
Most lenders only fund the purchase of finished goods because of the increased security if recovering their funds in a default or repossession situation. Should the borrower go out of business for example, the goods are simply repossessed, and either sold to the original buyer, or another buyer found. In 99% of cases, the funds lent are recovered, and the risk of not getting paid back are very low.
With raw materials, the risk is far greater. The finished goods have much higher value than the individual parts, and the lending is provided based on the retail price of the finished good. Therefore virtually all trade financiers steer clear of this type of transaction unless some other form of tangible security is available.
Why now Raw Materials?
One or two funders have decided that this is a concept they would like to expand into, subject to a suitable overall proposal. There is always a preference for some part of the process happening in the UK, but some deals have been approved where the transactions are wholly non-UK based, provided there is a UK limited company involved.
What will the funder need to consider?
When the borrower applies, the key areas under consideration would be following:
1. Experience – a funder prefers to see that the borrower has a track record of doing this sort of business, although start ups with strong purchase orders will be considered.
2. Purchase Orders – this is usually the critical element. If purchase orders are from customers that will credit score well i.e. highly unlikely default on paying the borrower, then funding of virtually any level can be provided.
3. Timeframe – how quickly is the cycle from order placed to sales revenue received from the buyer? Typically up to 6 months is preferred but it is now possible to access 2 to 3 year money in certain cases.
4. The Supply Chain Process & Partners – the more complex the supply chain and logistics, the more difficult it can be for the funder to get comfortable with its security and position. However, each case is different and is assessed in isolation.
5. How Security is taken – trade finance, from a lenders point of view, is a far riskier business than lending against a property or land. Real Estate does not move, get stolen, or get lost. As a result, a trade financier has to have certain controls in place to secure their position. This is “secured” debt finance after all.
How is security taken?
There are 3 different ways security can be taken, depending upon the borrowers business model and the supply chain set up.
1. Secure Title to the Goods – In most typical trade finance transactions, the financier buys the goods on the borrower’s behalf, therefore making direct payments to the supplier. The funder takes title to the goods and, if importing, will import under their own steam. The goods are released to the borrower or direct to the customer as is appropriate. However, in the case of raw materials, this isn’t always possible, and other alternative measures can be looked into.
2. Credit Insurance policy – Some borrowers will have this in place, and providing all parties are comfortable, the lender can take comfort that the policy covers their funding should any supply chain problems occur.
3. Other tangible security – if neither of these options are available, then the funder may look for other forms of security. This can take the form of property, shares, or other tangible assets that the business may own or have access to, that would cover the amount of the lend.
Ultimately, there is some subjectivity in how security is achieved and ultimately taken, but a funder, whilst willing to be fairly speculative, does require some form of security and ultimately needs to be comfortable about how they will recover funds in the worst case scenario.
Good News For Manufacturers
So the good news is a form of funding that traditionally was not available to manufacturing businesses is now accessible, subject to each case and proposal on its own merits.
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About Chris Davidson
Chris Davidson is Managing Director of Discover & Invest Ltd.
He believes passionately in providing businesses with market-leading financial insights that have a positive impact on the bottom line. As a result, Chris helps get the best rates and terms available at any one time.