FUNDING STOCK AND TRADING

Introduction

Funding stock and purchases has always been difficult as lenders have found it difficult to take effective security on which they can rely, and to value any such security as follows.

• The level of a business’s stock will move up and down markedly in many businesses, so knowing how much stock is likely to be physically there when the lender needs to rely on it is difficult.
• If the stock is valuable, easily moveable and easily sellable, this is a particular problem as it is likely to be gone by the time the lender needs to call on it. But if it is not valuable, difficult to move and/or sell how much value is it as security?
• In addition to tracking the quantity of stock, tracking its value is also difficult, as book values of stock are likely to be wildly different from its actual realisable value:
  • despite being on the books, much of the raw materials stock may turn out to be covered by suppliers’ reservation of title clauses and so may not actually belong to the borrower until paid for in full;
  • there is generally no market for any uncompleted work in progress after a business’s failure;
  • without a company to supply after sales service and warranty support, will the finished goods stock actually be saleable?
• In the event of an insolvency there is also a risk that the HM Revenue & Customs, may have distrained stock for unpaid taxes or the landlord may have done so for unpaid rent.

As a result true stock financing is rare, but there are some options available from a limited number of lenders, the key ones of which are:

• stock finance as part of an invoice discounting facility;
• stand alone stock finance;
• machinery dealer finance;
• trade finance;
• letters of credit and loans against imports;
• personal funding (eg through Fleximortgage).

Stock finance as part of an invoice discounting facility

As has been covered in the previous section, many of the factoring and invoice discounting firms will now advance funds against finished goods stock as part of their facility. In practice the advance is made by way of an overpayment against the debtor book, so for example, taking the percentage level of advance up from a nominal 85% to say a nominal 100%, but whatever the value of stock involved, the lender will still regard the debtor book as the core of their security.

To advance against stock, all lenders will, in the same way as the factor or invoice discounter will with debtors, need to become comfortable with the value of their security. This means they will need to undertake a detailed audit of the stock and will require you to run a detailed stock reporting system on a live basis to provide regular reports on quantity, value and movement of stock.

As the HM Revenue & Customs have the ability to distrain against stock for outstanding PAYE/NI or VAT balances, while your landlord has similar abilities in respect of rent arrears, the lender will also want a regular statement of your position in respect of Crown debt and rent payments. In order to be able to realise the stock should they ever need to, the lender may also wish to enter into an access and priority agreement with the landlord.

Stand alone stock finance

Having explained all the difficulties involved in lending against stock, it may come as a surprise to find that there are a number of lenders who are developing a range of stock financing products.

As a developing area it is difficult to give definitive guidance at the time of writing, but in addition to invoice discounting based facilities as described above there are for example the following options.

• Smaller end lenders offering initial facilities in the order of £30k, with some larger sums being available once a trading relationship is established.
• Short-term loans against stock which are in practice bridging arrangements and are costed accordingly at rates of up to 2% per month.
• Larger loans available, for example through banks in respect of stock balances where the value is in excess of say £5m, and therefore where the level of advance starts to make the costs of regular monthly monitoring and audits a more reasonable prospect.
• Term loans where a bank will sometimes convert part of a hardcore overdraft facility, that may have arisen in relation to a build up of stock in the business, into a term loan to be repaid over a number of years that is then described as a stock loan.

In addition to these arrangements some of the trade finance companies discussed below will offer finance by way of supplier undertakings. Crudely this can in effect mean that they use their ability to obtain credit to purchase goods that you need from your suppliers on your behalf, and then sell these on to you at a margin as part of a financing arrangement. This type of facility can be very useful where, for example, a business has a large and profitable contract to undertake, but it lacks the working capital to finance the required purchases, or where a business is in temporary cashflow difficulty and is therefore unable to obtain credit itself from its suppliers for the goods it needs. Each such arrangement will need to be tailored to the company’s particular circumstances and as a tailored solution will be costed accordingly.

Machinery dealer finance

The difficulty of borrowing against stock is a particular problem for businesses across the wholesaling, retailing, and dealing sectors where stock may be the main asset of a company.

Some industries have evolved particular arrangements to deal with this issue, such as motor trade main dealers where the manufacturers will often provide the local franchise with formal stocking arrangements.

In other cases finance companies have developed services designed to cater for particular niches. One key service exists, for example, for experienced dealers in machinery who can demonstrate a successful track record in spotting and converting opportunities at a good margin. This type of business generally requires a revolving facility secured against the equipment currently in stock, which allows the stock to be sold on and funds to be reused to purchase further items for resale. Since the security involved is an ever-changing level of stock this is an area where banks have often been reluctant to provide appropriate facilities.

As a result, independent finance companies can now provide facilities of up to £2.5m in the first instance to fund the buying in of assets to sell on. These can provide flexible funding that can be drawn down as required of up to 100% of the cost of the asset together with duty and VAT. This obviously provides the appropriate solution, but as a specialised product providing funding for areas where the banks are reluctant to do so because of the security risk, the cost of such borrowings will be high.

Trade finance

This type of funding brings us on to trade finance, which should be seen as the financing of a particular transaction or series of transactions, rather than as a loan to the business. Trade finance houses therefore provide cash to finance transactions that you have set up. A typical example might involve funding the importation of a container of goods from overseas for resale here.

The funding available ranges from:

• the funder purchasing the goods themselves, arranging and financing transport and customs clearance, only reselling the goods to you immediately before you sell them on; to
• the funder guaranteeing payment to the supplier but not actually having to remit funds.

The funder’s principal requirement when lending in such situations is the ability to clearly see the route through to the recovery of its funds. They will typically therefore look to:

• fund finished goods (although some will occasionally finance the purchasing of components for assembly prior to sale);
• support transactions with a high gross profit margin;
• see that a significant majority of the goods (sufficient to repay the borrowing) have been pre-sold;
• have terms that do not include any element of sale return;
• have creditworthy customers.

Critically for a trade finance house the success of the specific transaction being funded is what really provides them with their security. Therefore to be able to lend they have to be completely confident that they will be able to recover their money from a successful sale of the goods, which can affect their ability to fund. On the other hand, since they are looking at specifics of the transaction and are simply concerned with whether it may or may not be successful, they will also be very flexible about the type of transaction to look at and they will not necessarily be concerned:

• if your business is in financial difficulties;
• if the goods are being purchased from the UK or overseas;
• if the goods are being sold to the UK or overseas; or
• never even land in the UK.

So for example, in one case a trade finance house was happy to fund the purchase of a large quantity of electronic consumer goods for delivery in the autumn, even though the importer had not presold the consignment. This was because the finance company took the view that it could rely on the goods selling in the run-up to Christmas.

Advances and rates will be tailored to the specifics of the deal involved and type of financial support required. Some lenders will insist on factoring your debtors as part of such an arrangement, so that they can be paid out immediately on sale of the goods and a typical arrangement might therefore look as summarised in Figure 16.

Letters of credit and loans against imports

Where buying from an overseas supplier you may be asked to provide a letter of credit (LC). This is essentially a promise by your bank to pay the supplier for the goods upon production of the relevant paperwork, which is normally the documentation showing that the goods have been shipped. There are two main advantages of this to your supplier.

• First they do not have to rely on you for payment, but can trust your bank.
• Secondly, they can present the letter of credit to their own bankers as an irrevocable promise to pay for the goods once delivered, and use this as security on which to borrow from their own bank in order to manufacture the goods for sale, a process known as discounting an LC.

Where your bank issues a letter of credit this has the same effect as though they had promised to issue a cheque on your behalf and they will therefore take this liability (sometimes referred to as blocked funds) into account when considering how much overdraft facility to allow you.

So if you would normally have sufficient security to support a £lm overdraft, but you have issued letters of credit for £250,000 through your bank, the bank will normally only allow you an overdraft facility of £750,000 so as to maintain their total exposure to your business at under £lm, even though they may not have to pay out on the LCs for some months.

Once the supplier has provided the relevant paperwork and been paid out on the LC this cost will then be deducted from your bank account. Banks will sometimes offer a loan against imports (LAI) facility for say 120 days, which means that from the date of payment of the LC it will be 120 days before the cost is deducted from your bank account. This is designed to enable you to sell the goods and recover the cash from your customers in order to be able to meet the payment of the LC.

Obviously, where you are using trade finance your suppliers may wish to be paid using LCs from your trade finance house. If this is the case you need to be very careful as to how much you will be charged as shown in the following example.

The company imported goods from the Far East and provided its suppliers with an LC payable on shipping of the goods (generally three months) which the suppliers then discounted with their own bankers to fund the production of the goods. The company then paid off the LC within 45 days by selling the goods on once they had arrived in the UK and cleared customs. To fund a new line of business requiring £2m of LCs it sought quotations from two trade finance houses for which the charges were:

	Funder A	Funder B
Flat charge for funding the transaction
Monthly LC interest rate	1.75%	2%
Calculation of interest charge	Daily from date that the LC is paid out	From moment LC raised, calculated monthly for each month or part month

Most of the other terms and administrative charges to cover the costs of issuing the required documentation were similar.

The difference in the interest costs the business would face from the two lenders differed markedly, however:

	Funder A	Funder B
Total interest cost	Flat fee 3% + 2.6% (45 days at 1.75% pm) = 5.6% or £112,000	Three months since LC raised plus two months to cover the 45 day shipment and sale period gives 5 months at 2% per month = 10% or £200,000

Lender A also came up with a number of suggestions as to how the company could structure the transaction to avoid having to pay any interest, such as by issuing the supplier with a longer term LC so the lender did not have to pay out for 45 days after shipment, so eliminating the 2.6% interest charge.

Personal funding (eg through Fleximortgage)

As an alternative to seeking stock finance from institutions, if you own a business and have a significant level of personal equity in your domestic property, you can think about using a domestic mortgage such as a Fleximortgage to raise cash to enable you to act as your own stock financiers.

This involves borrowing money at domestic mortgage rates to purchase the stock personally for the business giving options to:

• only feed it in as required, thereby retaining ownership and control of the stock; or
• place the stock into the business, but take a charge over the business’s assets by way of security and again to charge a fee to the business for provision of this facility; while
• charging a commercial rate of interest for such high risk lending, which since domestic mortgage rates are generally amongst the lowest borrowing costs can enable you to turn a personal profit on this activity.

A Fleximortgage allows for easy drawdown/repayment of cash against the value of your property without penalties (up to certain limits and usually only if you have a good credit history). Giving advice on and arranging for borrowing against domestic property on a first charge is now regulated through the Financial Services Authority (FSA) hence mortgages are now known as ‘regulated loans’. You will therefore need to obtain advice from an appropriately regulated adviser if this is something you want to explore.