By Jon Richman, Head of Trade and Financial Supply Chain Americas, Global Transaction Banking, Deutsche Bank, and Joao Luiz A. Galvao, Head of Financial Supply Chain Americas, Global Transaction Banking, Deutsche Bank
Distributor finance, also known as channel finance, is built on the concept of a large corporate supporting an established network of key, geographically-strategic distributors to reach and expand their operations and sales into new markets. It is a revolving line of credit often available for a short-term basis and with the specific purpose to finance inventory purchases from the anchor supplier.
Origins of Distributor Finance
While distributor finance programs are relatively new for emerging markets, some large corporates have long been sponsoring these types of programs to support their distributors. For example, the automotive industry has continued to use distributor finance programs for dealer floor plan financing, allowing dealers to borrow against retail inventory. The dealer then repays that debt as they sell their inventory and borrow against the line of credit to add new inventory.
Addressing Today’s Requirements
Large multinational corporates (MNCs) are more dependent on emerging markets for growth and are making greater use of distributor finance programs to gain momentum in these markets. Distributor finance is often a preferable alternative to direct investments, particularly because of the limited impact on the balance sheet of MNCs. While strategically some MNCs may decide to build their own distribution channel, the business protocol is now such that MNCs should focus on their area of core competence. Nowadays, we rarely see a major corporate opting to invest in vertical access to the retail market end users or to establish subsidiaries with the purpose of carrying local inventory to diverse geographic locations. In addition, the treasury professionals of those MNCs are under increasing pressure to manage working capital more efficiently. Often these new distributors are thinly capitalized so their open account credit limits are quickly reached and not sufficient enough to support the distributor.
The distributor finance programs offered by a bank with the support of the MNC provide some tangible opportunities:
- The MNC benefits by boosting its revenues and limiting the impact on its balance sheet, as the bank will finance and take the credit risk of the distributor.
- The distributor benefits as it will gain access to a revolving line of credit to finance inventory often under better conditions than it can obtain from its local banks. Also, this financing can be supplementary to existing relationship banking arrangements.
Further benefit to the MNC will depend on the individual corporate. The bank needs to deepen its discussion with each corporate on the structuring of their distributor finance programs and how they differentiate from other finance alternatives such as accounts receivable purchase and straight working capital management solutions. Distributor finance can be structured with minimal involvement of the anchor supplier, or with a higher degree of support. A minimal intervention could be a simple acknowledgement by the MNC to the bank extending a specific line for its distributor. A minimal intervention from the MNC could also reflect in greater need for due diligence in terms of the bank’s analyses of the distributor.
On the other hand, a higher degree of support would involve some risk sharing, some subsidy on the interest rate charged on the finance to the distributor and therefore, a more comprehensive approach by the bank. This structuring flexibility allows the distributor finance programs to be a better solution and in some cases is the only solution. For example, the distributor finance program does not have the limitations of a securitization program which has strong restrictions in concentrations and often excludes foreign risk – similar to a simple receivables finance program which would require the MNC to extend payment terms to the distributor and would necessitate a greater degree of involvement and change in internal billing procedures.
The benefits for the distributor, which ultimately also benefits the MNC supplier, are more evident. By sponsoring these programs the MNC increases the purchase power of its distributor and the distributor can support a more prompt delivery of its products. It is proven that a customer is more likely to purchase a product that it has immediate access to than to buy a product which it will have to wait for a few weeks or even months. As mentioned, there is also a very tangible financial benefit as the distributor finance programs are usually much cheaper than local working capital bank finance. If the anchor supplier is willing to subsidize the financing the benefits are even more significant.
The bank you choose to partner with for distributor finance should have a team of product experts trained to structure these highly customized cross-border multi-currency finance deals. An experienced structuring team will look for distributors that have a vested interest in succeeding in selling the products it purchases from the MNC.
Usually the distributor will purchase a sizable portion of its products from its anchor MNC supplier. It will also have a few years of commercial relationship with the MNC and a good repayment history. The line of credit will be sized and monitored accordingly and other credit review criteria will apply such as financial statements review, access of management, etc. In the end, the combination of a satisfactory structuring, commercial history, business dependency and some minimum creditworthiness makes the default rating arising from these adequately-sized, short-term revolving facilities very low. Therefore, this type of financing can provide more flexibility on better terms than straight working capital.
The Right Partner Bank
For a distributor seeking a distributor finance line or for a large corporate looking to establish a sponsored program to its distributors, choosing the right bank partner is fundamental. The right bank will have a global presence and the ability to support multiple countries and markets.
Deutsche Bank has the global reach and the depth of expertise to assist its clients with their expanding distributor finance needs. Distributor finance is a fast-growing product for Deutsche Bank as there is increasing interest in this type of financing from MNCs as they enter new markets.