A Short Guide To Finance Options

On Saturday November 7, the Institute of Agribusiness Management Nigeria invited me to join a panel talk on innovative finance options for supporting value chain developments in commercial agriculture. One thing we all agreed on was that agriculture need financing options that not only funds different steps in the value chain but work in tandem with the cycle of the different crops or live stock. In agriculture, timing is everything. An intervention fund that takes three months to process does not help a business with a 30-day or 8-week cycle. The problem of application and approval process is an endemic one that needs to be re-thought. Until such a time however, businesses have to re-adjust their timings on when they apply for financing and make sure that they are fully prepared with all required regulatory documentation, operational processes in place and transparent financial history made available to ensure a greater success of securing much meed finance.

Knowing what your options are is a task in itself. Below we have compiled a short guide into different finance options avaiable at different stages of business maturity and for different needs. Most are applicable to any type of business not just commercial agriculture.

Export Finance

Enables you to source working capital to continue operating whilst waiting for your invoice to be paid, acquire the money to ship the product ordered and/or pay for the production of the product order if you are operating further up the value chain.

• Factoring aka Invoice Discounting

  The business sells its invoice to a factoring company (bank or non-bank lender) for a percentage of the value of the invoice, normally 80%. Once the product is received by the buyer and the agreed payment period has been reached, the buyer pays the factoring company, the company pay the business the outstanding 20%.

  The Factoring Bill has had its seconding reading in the House of Assembly and still awaits its approval before it becomes a funding option in Nigeria.

  Things to consider

  This is a useful alternative for businesses that lack or have a poor credit history or if you have been a broker with access to buyers who are willing to give you contracts to supply directly. It frees up much needed working capital to aggregate or produce product and ship it. However, it is important to ensure the right incoterm is agreed and does not leave you with insufficient funds to ship to the buyer because you are responsible for various parts of the export process once boarded on the vessel.

  Factoring facilities are normally issued by international factoring companies or banks in the local market.

• Pre-shipment Finance

  This the most utilised finance instrument for export finance and typically what most businesses apply for. It is a single or revolving loan to pay for the shipping costs of exporting. Finance providers will not approve this type of finance to new businesses, an existing business diversifying into a different sector or product (banks may be more lenient here because there's an existing relationship in place) or a business that has operated in the given product segment but has no records of transactions on its balance sheet.

  Things to consider

  You must have a solid history (normally 3 years) of trading in the product been exported plus 12 months management accounts and 3  years of audited accounts. You will also collateral which would normally be land, property, life insurance, treasury bills, bonds. The land and property accepted must be in Lagos, Abuja and maybe Port Harcourt. The value of the collateral or collective collateral must exceed the value of the finance.

  If you default the collateral is lost.

• Post-shipment Finance

  This is given after the shipment of goods is complete, shipping documents have been submitted and are in possession of the finance provider. The title of goods is the most important document here. Up 100% of finance can be made available as this an advance on accounts receivables (the payment that will be received by the borrower from the buyer who has essentially bought on credit). This is ususally an option for exports on deffered payment periods for over a year but can also be made available for short term periods. If it is used for cash exports, the maximum payment term allowed is six months.

  Things to consider

  Ability to manage your accounts will be absolutely key factor here. This should not be used as an optiion for revolving credit, it is better to re-negotiate better payment terms.

• Supply Chain Finance

  Like factoring, this is ideal for new businesses or those with no or poor credit history. However unlike factoring, the supplier leverages the creditworthiness of the buyer. The supplier gets immediate payment for part or all of the receivables, offering a small discount or pay a small finance charge in return. The buyer sources the finance which is issued against their credit history and often at a more favourable rate. As the buyer pays back the finance, they will negotiate extended payment terms. Amongst other things it helps to strengthen the stability of individual trade entities as well as the trading relationship.

  It is not a loan. It's an extension of the buyers accounts payable (a short term debt that needs to be paid to avoid default) and is not considered financial debt. For the supplier, this represents a true sale of receivables. As there is no lending, it does not impact either parties balance sheet.

  Things to consider

  The buyer will usually be a corporate company and must have a strong credit history. This financing option is wholly dependent on trust between both parties. If you fail to supply the contracted product or deliver late, the buyers credit rating will be negatively impacted if they default. This could happen if they are over leveraged. They certainly will never do business with you again and they will likely ensure news of this transaction gone wrong spreads through the buying community. Your reputation is irrecoverably damaged and you may find yourself shunned by businesses in that sector (networks are small and tight) in that country.

  This is also known as reverse factoring.

• Warehouse Receipt Invoicing

  A form of inventory financing where the goods or commodities stored in the warehouse are used as collateral against the loan. The business is given a percentage of the value of what is been stored in the warehouse. Finance providers that do this normally appoint a third party collateral manager who issues a warehouse receipt to the borrower confirming the quality and quantity of the goods in the warehouse.

  For smaller businesses without their own, a community warehouse where different businesses store their commodity is an option. Cooperatives can, and often, run such warehouse for their members.

  In addition to much needed cashflow, this also solves the poor storage issue and price volatility in the commodities market. The business can wait and watch for higher prices and demand before selling.

  Things to consider

  The content of the warehouse now belongs to the finance provider so if you default, they will sell the contents of the warehouse to recover the loan. If you are an aggregator or broker that means you have no commodity to sell. You are likely to lose some supplier relationships and you will have damaged your reputation too.

  Use licensed warehouses if you are not storing in a community warehouse not run by a trusted cooperative or trade organisation.

  Fraud is a problem to bear in mind here. Even the finance providers collateral managers will steal some of the contents of the warehouse if they can get away with it. Make sure the provider has a robust insurance offering in place should anything go wrong.

  This may not be an option in rural areas unless you have your own warehouse.

Asset Finance

Enables a business to buy equipment, machinery or vehicles without paying everything upfront. Factoring or invoice discounting financing are typical options here.

• Asset Backed Finance

  Allows you to release the value of your exiting assets using them as a guarantee against a loan.

  Say you have a piece of machinery bought on hire purchase for $100,000. You have paid off $80,000 with $20,000 still outstanding. You can borrow up to $70,000 (up to 70%) of the original value of the machinery. $20,000 will be used to clear the original hire purchase agreement, freeing up $50,000 for you to buy new assets. The asset is acts as collateral.

  Things to consider

  If you default on payment you will lose the existing machine if the $20,000 is not paid off yet as well as the new asset.

• Finance Leasing and Hire Purchase

  For additional assets, there is also the option of leasing for full outright ownership, returning the asset or getting a newer version.

  You pay monthly instalments for an agreed primary period. The asset is usually close to the end of its working life according to manufacturer expectations making it a long term option. Once this period is over you have 3 choices:

  1. Continue leasing the asset for a secondary period but at a cheaper rate
  2. Sell the asset and keep a share of the sale
  3. Return the asset to the leasing company
  
  

  Things to consider

  The difference between this and hire purchase is where it is accounted for in your management accounts. Hire purchase shows on your balance sheet (a report showing the company's assets, liabilities and shareholders' equity), finance leasing is accounted for on your operational costs where you can offset rentals against profit.

• Operating Lease

  If you go down this route, you do not take on the risk or reward of outright ownership. For instance, you do not need to worry about maintenance, servicing or repairing. You're just renting an asset for a short to medium term period.

  Things to consider

  This can be an expensive option.

• Import Finance

  This is standard import loan borrowed to cover the cost of the product or goods been bought. It can be short, medium or long term facility depending on what is it used to buy.

  Things to consider

  This will leave an immediate cash gap in the business if paid back immediately which could potentially lead to cashflow issues and the need for working capital.

  With asset financing, the assets will be seized if you default.

• Letter of Credit

  This is issued by a bank as a guarantee that the buyer will pay a supplier according to the agreed incoterm and payment term and the buyer does no need to pay until the goods have arrived. If the buyer defaults, the bank pays the supplier.

  Types of letter of credit:

  • Irrevocable - cannot be changed or cancelled unless everyone involved agrees hence they tend to be more secure
  • Revocable - can be changed or cancelled by the bank that issued it at any time and for any reason
  • Confirmed - as a seller, you will to check through your bank that the letter of credit is valid. By confirming the letter of credit, the local bank agrees to guarantee payment even if the issuing bank fails to make it. Again, this is more secure
  • Unconfirmed - no confirmation of the letters' validity so there is no recourse if the issuing bank fails to pay
  • Transferable - can be passed from one ‘beneficiary’ (person receiving payment) to others. They're normally used when intermediaries are involved in a transaction
  • Standby - an assurance from a bank that a buyer is able to pay a seller. The seller doesn't expect to have to draw on the letter of credit to get paid
  • Revolving - can cover several transactions between the same buyer and seller
  • Back to back - may be used when an intermediary is involved but a transferable letter of credit is unsuitable
  
  

  Sometimes, two types of letters of credit can be combined, 'transferable' and 'standby' for instance.

  Things to consider

  As the seller, you will ony receive payment once you have meant every element of the letter. There are often clauses to cover issues around discrepanies in weight, spoiled good etc.

  As a buyer, if you default on a letter of credit, it will be almost impossible for you to get one from any other financial institution.

  If you are both a seller and a buyer, and there are issues of fraud in your warehouse, which mean a percentage of the goods or commodities were never sold, again it will be difficult to find another bank that is willing to issue you a letter of credit.

  As this is a guarantee, it is expensive but essenital especially in international trade and/or those of large value.

Project Finance

Enables project owners to raise finance to fund all the costs in the business - operations, land, equipment, partners etc.

• Debt Financing

  A long term loan that is issued by an investment bank for the development of a project.

  Things to consider

  Financiers will not offer debt to greenfield/startup projects unless it is a new project coming out of an established company. Long term debt will only be issued against offtaker agreements and a financial history that demonstrates a projects ability to cover operational costs and repay the debt with ease.

• Equity Financing

  A percentage of equity in the business is sold to an investment bank, private equity firm or a consortium of investment financiers in return for cash to develop a project. Like debt, this is a long term option.

  There will be an agreed multiple of the original financial investment that you must eventually return back to the financier when they sell their equity to another equity firm, you sell the company in a trade sale or list the company on the stock exchange through an IPO.

  Again, your ability to produce offtaker agreements, letters of intent, memorandums of understanding, supplier and/or distributor partnership agreemnents are key here.

  Things to consider

  Selling equity means the financier is now a key stakeholder in the business. They have just as much to lose as you so they will be injecting their operational and sector expertise to ensure the business delivers its full potential. They will open up their contact books secure distribution or supplier partnerships so the business scales quickly.

  Before anyone writes a cheque you must show that you skin in the game, what or how much have you personally invested yourself.

  This option tend to have a complex structure so make sure you have a corporate law firm with experience of doing private equity deals in your sector working with you to negotiate the deal.

• Blended Finance

  A mix of debt and equity financing.

  Things to consider

  The ratio of equity versus debt you raise will depend on various factors including whether it is a greenfield or brownfield project, the part of supply chain the project is in, if the project is operating further up the value chain, the experience of the project owners and the project delivery partners and so on.

Alternative Funding Options

These are new finance options that are more familiar in other sectors but could be utilised in the Agriculture sector.

• Angel Funding

  This is ideal for startup businesses looking for long term funding. Like equity financing you will be selling a percentage of equity in the business. This will either be to a high net worth individual aka Angel, multiple Angels or a syndicate of Angels.

  Things to consider

  You are essentially about to be wedded to someone or a series of individuals who have a controlling influence over your business. It is absolutely essential that you are comfortable with the individual or individuals.

  Like a private equity firm, Angel funding should come with more than money. The Angel(s) should have experience in your sector, be able to lend you their operational expertise, be able to connect you with distributors, suppliers or other prospective partners or have connections to help with recruiting the best people into the company. If possible, choose Angels with experience in agriculture, agribusiness or logisitics if you're going to be aggregating from multiple stakeholders. They understand that this a long game and returns are not immediate.

  If you run out of money before you are able to secure additional funding, the business will be liquidated and depending on the terms of the agreement, you may be held personally liable for repaying the money back to the Angel investor(s).

• Venture Capital

  The same as above but for those now at their second or third funding stage to drive growth.

  Things to consider

  Remember, each time you take on another equity funding round, the less you own of the company. Your job during each round is to make sure you have significantly increased the value of the company through increased sales and strong pipeline otherwise you will end up with a down round (the price per share is lower than the price from the previous round).

  As above, if you run out money before raising another round, the business will be liquidated and you may be personally liable for repaying back the money.

• Crowd Funding

  As the name suggests, you sell either your product to get advance payment from the "crowd" - direct consumers or trade buyers - or sell equity to the crowd.

  Things to consider

  If you're selling an agri-product what happens in the event of crop failure, drought, disease etc? What have you put in place so the crowd have a recourse back to the money they invested.  Remember, these are mainly ordinary citizens who are buying. Adding insurance to cover any such event protects you and the crowd (though this is not applicable to equity crowd funding). Remember, each negative experience makes it harder for the next business that comes along.

No matter which funding option you decide to choose, you will lose something or everything if you default. The one thing that is not optional is the need to ensure your business is bankable, doing 'anyhow' will not secure you finance. This means your operations, financials, team and partners must illustrate your commercial abilities and prove that the financiers money is in good hands.