Supply chain finance (SCF) programmes may take centre stage today, but waiting in the wings is distributor finance (DF). Corporates across the industrial spectrum are now looking at supporting downstream businesses in their supply chains via DF programmes, particularly in emerging markets (EMs).
Both corporates and banks are showing a growing interest in distributor finance (DF) programmes, according to research by Demica, a working capital solutions company. Many global manufacturers wanting to ship more goods into dynamic emerging markets (EMs), such as Eastern Europe, Asia and Latin America, are introducing DF programmes for their distribution networks.
At a time when small and medium-sized enterprise (SME) distributors are struggling to obtain affordable credit in many EMs, DF programmes are being used to support the working capital needs of a corporate seller’s distributors. It gives them access to affordable finance, enabling them to increase sales and grow business volumes with lower capital requirements. This in return allows sellers to expand into new or under-served regions/segments and unlock sales potential.
According to Demica’s research, corporate respondents exhibited rising interest in DF products, largely due to their ambitions to expand into EMs. Corporates implement DF solutions in order to:
Increase sales in high growth regions without applying more of their own working capital.
Give the offered product a competitive advantage.
Reduce SME distributor risk.
Make favourable financing available to the distributor base.
One of the main considerations when developing and implementing DF programmes is the risk involved. The Demica report lists a number of common approaches that can be deployed to manage credit, business and country risk in DF programmes. These risk reduction mechanisms include seller support, assets as security and structural risk mitigation. The seller, for example, can help mitigate risk by providing detailed information on distributor history, performance, inventory levels etc. It can also introduce first loss default guarantees (FLDG), potentially shared with the banking partner.
“From the funder’s perspective the big issue is who bears the loss if the distributor goes bust,” says Phillip Kerle, CEO of Demica. “A bank may be prepared to take on a percentage of the risk, but this percentage depends on the commercial strength of the manufacturer. If it is a large multinational IT company, then a bank will be more prepared to shoulder the risk; whereas if it is a family-run shampoo manufacturer, for example, then a bank may not have the same risk appetite.”
Setting up a DF programme calls for the consideration of the principal legal, regulatory and tax and accounting elements, therefore a complex tailored approach is required, according to the report. From the legal perspective, perfection of the true sale (of receivables) and/or security, including requirements on notification and/or acknowledgement, needs to be carefully structured. Country sovereign risk, insolvency laws and commingling risk as well as off-set risk (credits) all need to be taken into account in determining legal framework predictability and stability.
Case study: mobile manufacturer
One of the report’s case studies focuses on a global tablet mobile device manufacturer that has a distributor network mainly consisting of SME entities. In some EMs, this group constitutes a large portion of the sales. These distributors generally have limited access to financing. Even though their financing needs are short term (normally no more than 90 days), the volumes can be high, particularly in EMs where a single distributor handles large sales volumes. As business margins are thin, distributors need to have access to reasonably priced financing.
This manufacturer set up several DF programmes in co-operation with large global banks as well as local banks, depending on the country conditions. These programmes offer revolving type, short-term credit lines for 30-60 days. Such facilities are extended by the international or local financing bank and normally require a personal guarantee by the owner of the distribution company or a pledge of physical assets as collateral. In terms of eligibility for the programmes, in addition to the company’s own selection criteria (e.g. history with distributors, share of business, etc), the banks may also impose certain criteria on the distributors. The volumes of financing vary across different countries, but most are over US$5 million.
End-to-end: linking up DF and SCF
Although DF solutions can complement supply chain finance (SCF) programmes in providing efficient financing for SMEs both upstream and downstream within a major corporate’s supply chain, Kerle doesn’t believe that the two will link up end-to-end anytime soon. “Although the common theme is invoice-based financial transactions, I think the two programmes exhibit different dynamics. A DF programme is probably easier to set up than an SCF programme, mainly because smaller distributors are captive in relation to the manufacturer, whereas more persuasion is needed to encourage suppliers to participate in an SCF programme.
“Therefore, I think they will remain separate to an extent. But banks will need to be flexible as to what they offer, whether it is traditional financing, invoice discounting or asset-backed lending. They need to offer a range of invoice-based finance programmes.”
This insight was first publishedon www.treasurytoday.com