This pre-recorded SupplyChainBrain podcast featuring LSQ CEO, Dan Ambrico, focuses on navigating suppliers’ liquidity dilemmas in a pandemic-stricken economy with dwindling access to working capital from traditional lenders. If you’re experiencing a cash flow crisis or curious about how small suppliers are generating capital without increasing debt, this is a worthwhile listen!
Dan Ambrico, Chief Executive Officer at LSQ
Bob Bowman, Editor-in-Chief at SupplyChainBrain
Bob (Host): In terrible economic times, companies of all types suffer, but small business gets the worst of it. Hi, everybody I’m Bob Bowman, editor in chief for SupplyChainBrain, and this is a SupplyChainBrain podcast.
Access to capital is a chronic problem for small business even in a good economy. Now, however, with customers stretching payment terms to protect their own cash reserves, and the demand for product down in so many sectors due to the pandemic, the situation is especially dire. What’s a small business burdened by heavy receivables to do? It turns out there are a number of creative options that can bolster balance sheets in the form of working capital solutions. The possibilities are especially interesting when it comes to supply chain finance and financial technology, or fintech.
Today, we’ll review the working capital landscape with the help of Dan Ambrico, CEO of LSQ. We’ll explore how small business can get in a game that strongly favors larger corporations whose need for cash is less severe. For companies at the low end of the credit spectrum, how can they gain access to much-needed liquidity? Here’s my conversation with Dan Ambrico.
Bob: Dan Ambrico, welcome to the show.
Dan: Happy to be here, Bob.
Bob: Dan, who today is most in need of working capital solutions?
Dan: To me, it’s the small business sector. There’s been a lot of ink spilled about small businesses, and the impact that coronavirus has had on the small business sector. In my opinion, the small business sector is the one that lacks access to traditional forms of capital. Even in normal times, they are a hard group to finance, and then when you layer on top of it, a period of volatile demand, it makes it very difficult for the small business sector.
Bob: We’ve seen, have we a big uptick in receivables in these weeks and months as a result of what’s been going on?
Dan: We have seen in our own businesses, depending on the industry you’re in. If you’re in the leisure or hospitality or energy industry, your business could be down anywhere from 20% to 50%. If you are in the retail industry, you’re experiencing lots of ups and downs in demand and disruptions in their supply chain, which is causing a lot of volatility. Big companies are starting to stretch out their payment terms, which is pushing up receivables balances for a lot of companies, but in general, most companies have seen lower volumes over the last six months.
Bob: As they stretch out their payment terms, certainly that threatens the stability of the suppliers themselves does it not?
Dan: It has an impact on their cash conversion cycle. Anytime a big company or a corporate stretched out as payment terms, that liquidity comes directly out of their supply chain. They have to find a way to bridge that gap and so every 30 days can represent payroll, utilities, there’s lots of cash needs for a business. It has a negative liquidity impact on smaller businesses that don’t have a traditional line of credit or something like that.
Bob: Now our interest here is in supply chains, specifically global supply chains. What is the situation there? You have a whole universe of suppliers that relationships are long-lasting, but can also be very perilous at times like this. Do you see the same situation playing out on a global scale?
Dan: Yes, I think there’s a bunch of forces at work here. First is there’s some geopolitical forces where companies are starting to think about where they source product from and thinking about the stability of their supply chains in foreign countries. You’re seeing this, particularly around medical equipment trying to onshore some of that. You’re also seeing companies think about just-in-case versus just-in-time inventory management, meaning you’re wanting to have more product on hand, because A, you’re not sure you can get your hands on it, or B, demand environment is very volatile.
That’s having an impact on how everybody’s thinking about managing supply chains. Then there’s just the actual impact on physical spaces themselves and the creation of products and the logistics and the ability for those pick and pack logistics hubs which bring goods into the country being impacted, sometimes having to shut down sometimes having to reopen so it’s messy out there.
Bob: What is a small supplier that is owed money to do? What are some– you had to mention stretching out payment terms is one response of the company that’s paying, but what are some creative working capital solutions out there that are being devised to address the situation?
Dan: Because small business doesn’t fit into a clearly defined box, the credit and financing products associated with it are very diverse. The ones that I think are the most interesting innovations to me are around working capital and providing financing either against receivables or in supply chain finance. There’s also merchant cash advance and other products that address a B2C space, they’ve been around for a long time. I don’t think you’re seeing as much innovation there, what you’re seeing really is a lot of automation. Companies, particularly larger companies are starting to try and put in place automated supply chain programs, which help their suppliers access liquidity on demand.
What I mean by that is, I’m Coke, I have my suppliers on 120-day payment terms, I offer them access to a supply chain finance program where they can, for a discount, access liquidity when that invoice gets approved, let’s just say on 20-day terms. I’m saving them 100 days of potential liquidity shortfall. I think you’re seeing a lot of that. That to me is a very effective way to deliver liquidity to small businesses because it’s within an existing relationship, you can automate a lot of it, there’s validation on the side of the corporates, you can even leverage the corporate balance sheet and cost of capital.
To me, that’s one of the more innovative ways to get capital to small businesses. Then there’s a bunch of other ancillary products around PO finance and inventory finance. Frankly, none of them are very scalable. A lot of them are very expensive.
Bob: The tricky part there, as you said, offering the discount, that, of course, means that less money ultimately flows to the entity that is owed money. Does that after a point, put them in jeopardy? Yes, they get paid earlier. Yes, they get paid on time, but they get paid less. What is the point at which that balance goes to the point where it’s not worth it?
Dan: I think particularly in thin margin businesses like retail, you find there’s already most of the blood has been squeezed from the stone to the extent you’re putting a large discount on top of the invoice to finance, that may tip over a lot of small businesses. The margin profile of the industry is very important for that product to the extent the industry has a sufficient margin, like healthcare and other industries, it tends to work really well. As you go down to industries with thinner margins, it gets more complicated.
It’s really also about what is that supplier’s ability to access capital in the market and how much will it cost them? Oftentimes, they don’t have access to very cheap capital so they may bake some of the financing costs.
Bob: They anticipate that in advance and anticipate what’s going to happen.
Dan: Yes. They pass it through. Actually, supply chain finance programs can be a way to boost margins, because you’re lowering the cost of capital for your suppliers.
Bob: You noted sometimes they have trouble, the cost of capital can be high in the marketplace for them but sometimes, their larger customer, they can avail themselves of the larger customers’ access to the capital at lower interest rates. How common is that these days?
Dan: That’s really at the core of a receivables space for Supply Chain Finance product, is you’re leveraging the credit profile of your customers and their financial health and their cost of capital. That’s why I think it’s a very effective product for small businesses because they simply don’t have access to that liquidity at that price.
Bob: The role of intermediaries in this too, let’s say a third party that comes in and takes over the receivables pays it off, that’s a thriving industry to a certain extent, is it not?
Dan: Particularly in times like this, where you’re seeing payment terms get pushed out, where you’re seeing banks and other traditional lenders that offer lines of credit, or a traditional, let’s call it ABL type facility pull back from the market, that’s where somebody that’s leveraging a receivables based finance product or you’re taking that as collateral can be effective because there can be quality receivables. You can use those receivables to generate liquidity to fund the business.
You’re seeing it in times like this, it’s a very countercyclical product. As the world and financing sources get more risk-averse, and you see payment terms being stretched out, you see that product go up in popularity.
Bob: Now when it comes to making decisions on invoice financing, to get back to this question of the small versus the large body here, the so-called know your customer, the importance of KYC, know your customer and compliance certainly does play a role but I think you would make the argument that it’s not the whole picture. What beyond that has to come into this calculation?
Dan: I think there’s a couple of things. KYC is a way for– banks particularly rely on it as a way to mitigate fraud risk, money laundering risk, OFAC things like that. It has an importance there and it adds a lot of friction to the process and slows down potential onboarding processes because banks have to check a lot of boxes that other financers that aren’t regulated financial institutions do.
The other thing that’s important is business history, quality of the customers. Those are things that are also important in any underwriting process when you’re looking at a facility like that, outside of just who they are and doing some basic high-level background check and credit check
Bob: Interest rates, of course, have been low for some time. When interest rates are this low, how does that affect the situation of receivables and small businesses? I guess it certainly helps because cost of capital is less, but what happens when interest rates go up? I have to take it the situation that happens eventually is going to get even more dire for them.
Dan: Yes, right now the bigger problem is less about cost of capital is just lack of availability of capital period. When you’re thinking about the small business sector, even within industries, companies have different margin profiles and different survival chances. For lenders, it’s very hard to pick and choose winners and losers. In the consumer space, it’s very easy because you have a very clearly defined box with FICO score and employment history, not so much the case in small business. It’s a very difficult space to finance.
Even in a low-interest rate environment, you’re worried about solvency risk, and so no cost of capital makes sense for certain lenders. What you’re finding now is companies at the lower end of the credit spectrum just simply don’t have access to the market at any price. In normal times, a low-interest-rate environment should have a downward impact on pricing and you are correct, and upward trending interest rate environment would have an upward effect on pricing. In an environment like this where people are worried more about stability and survival, capital is just not accessible period
Bob: I wonder what the larger impact or at least the larger issue of debt in general, how that affects this whole situation because the alarm bells were going off long before the pandemic started, just about the huge levels of corporate debt out there. That’s got to hurt and that’s still a problem and even more so now. How do we put that in context of the situation we’re talking about and how it affects the whole world of working capital?
Dan: There’s two ways to think about it. First is we are currently trying– to your point, we’re trying to solve the problem with too much debt with more debt. What you’re seeing right now are companies are further levering up to solidify liquidity on their balance sheet and anticipation of the tougher times ahead. The problem with that is at some point, those bills come due, and so you’re adding more leverage to the system. If you think about a small business, the challenge for you is assessing the financial health of your customers. Your customers potentially have taken on too much debt during good times, and now have a leverage problem and a potential solvency problem.
It’s never been more important for a small business to have a good understanding of the financial health of their customers, and if they’re taking on new customers, to not be afraid to look at their balance sheet and understand if they are healthy or not. To me, that has a downward impact. The problem of too much leverage in the corporate sector is going to have a impact more broadly than just corporate default. It’s going to cascade down market, small business as well.
Bob: Everything cascades down to small businesses, they suffer in all cases it seems. To what extent are these small businesses that we’re talking about, even aware of the options that are available to them? I’m thinking specifically of supply chain finance, which I think is still a young industry in terms of awareness and acceptability. Tell me if I’m wrong about that, but I’m wondering, is there an awareness that these programs are out there and that these possible solutions are available?
Dan: Oftentimes there’s not. To your point, it’s been around for a while, but it’s been a very niche product used by companies in certain industries like auto parts and aerospace, where there’s very long payment cycles. As it’s broadened out, I don’t think a lot of suppliers are aware that it’s accessible to them. Part of that is the corporate doesn’t have necessarily a lot of resources marketing the product itself, and so potentially a third-party funding partner may be responsible for doing that marketing.
It’s inefficient, it’s ineffective. The education’s not there. The other problem is it may only solve one problem for that particular small business meaning one customer is now paying them faster, but they have five others who aren’t. To the extent that they can find something more broad, that may be more impactful than just solving 10% of their problem.
Bob: There’s also the question of vetting the particular parties out there that offer potential solutions in a world, in which as you say, banks have pretty much pulled away from this role, especially for small companies. A lot of non-banks have insinuated themselves into the business. Some of them very good at what they do and some of them may be a little less trust. How can these small businesses even begin to assess the viability or the potential solution providers?
Dan: Let me break it down in two ways, the bank programs for supply chain finance, to your point, largely are driven by fortune 500 companies. Banks will rarely look to do a supply chain program outside of let’s call it the Fortune 500 and those type of credit profiles. Bank programs, the shortcomings there, if you are thinking about it from a small business perspective, it’s a manual process, it could be a lengthy onboarding process, banks will put you through their KYC. It can take a couple of weeks to access the program.
If you transition over to looking at the fintech players that are trying to address supply chain finance, they’ve done a very good job of improving the user experience, automating a lot of the manual processes, both on the integration side to get data from a corporate, and for the supplier to onboard and access capital. The user experience is much better. The problem is they also lack the balance sheet that a bank has. Capital sources are less predictable, cost of capital is less predictable, which can inject uncertainty and for a small business, what you really want is how much is it going to cost me? Is it always going to be available?
What you really want is something that’s in the middle, where it’s predictable, reasonable cost of capital, with a lot of the automation that we’ve seen in the market. We’ll ultimately get there but I think we’re not there yet.
Bob: Where is it all going, Dan? We’re in a period of great peril in this economy, no one knows how long it’s going to last. A lot of companies are going to go out of business, notwithstanding the availability of such programs. Where is working capital solutions / fintech / finance of the time we’ve been talking about today? What role will it play as helping us to navigate the future? What types of solutions might step forward and be most popular, given the uncertain climate we’re facing today?
Dan: Right now the government’s trying to play a role to step in as financial institutions back out. In my opinion, that’s temporary and that’s a band-aid if you will. Longer-term, there needs to be a broadening in the way small business can access reasonable cost capital. In my opinion, the best solutions I’ve seen out there are ones that take an integrated approach, like supply chain finance, like what Square and PayPal have done in their ecosystems, offering their merchants capital, where you know who they are, you have a relationship with them, you’re delivering it in a seamless way, there’s good data to underwrite the risk.
To me, that’s where the world of working capital is headed. The biggest pain points for most commercial lending platforms are, it’s hard to underwrite customer risk because there’s not good data. It’s hard to find them so customer acquisition is expensive. Because customer acquisition is expensive, the products tend to be expensive, so the rates are high. To me, the integrated approaches like what we’ve seen Square Capital do, like what supply chain finance is trying to do, integrating with the corporate, is the most effective, efficient way to deliver liquidity to small businesses.
What it needs to do is mature, it needs to broaden out and I think it will help a lot from a funding standpoint. I don’t think it’s there today. I don’t think it’s certainly there to meet the needs of today’s small business where demand is collapsing all around and funding sources are drying up. Ultimately, I do think those are going to be the winning structures long-term.
Bob: Do you think that fintech itself will mature to the point it will become just a better option for companies?
Dan: I think so. Fintech has done a really good job of evolving the user experience and bringing lots of automation to what was manual processes and trying to expand the addressable universe. Where it falls short, of course, is it’s very immature from a risk management standpoint. Putting money out the door is one thing, getting it back is another. I think over time, the industry will mature get better at risk management and I think you will see it continue to grow as a share of the overall sources of liquidity and capital available to both businesses and consumers.
Bob: It’s good to know that as miserable as this economy is right now and as perilous the state of small businesses these days, that there are some solutions out there that they can avail themselves of. Dan Ambrico thank you so much for enlightening us on what some of those solutions are and giving us a sense of the state of working capital solutions today. Thank you very much for being with us today.
Dan: Thanks, Bob. Appreciate it.
Bob: That was my conversation with Dan Ambrico with LSQ, talking about working capital options for small business. We’re online at www.supplychainbrain.com where we post a new episode of this podcast for streaming or downloading every Friday. You can also read my Think Tank blog, watch thousands of videos, and access all of our other content, including the digital edition of our magazine.
Look for us on Facebook and LinkedIn and follow us on Twitter @SCBrain. You can also download or subscribe to the podcast on Apple Podcasts. For any comments or suggestions on this or any episode, email me at firstname.lastname@example.org. Stay well and see you next time.Listen To The Podcast