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Small Business | FINANCING AND INSURANCE / JUAN HOVEY

Purchase-Order Loan Gets Avionics Deal Airborne

March 25, 1998|JUAN HOVEY

Richard Probert, owner of a Long Beach avionics company called AeroTechnology, knew diddly about the art of raising working capital five years ago. He just saw an opportunity to make a quick $150,000, and he needed cash to do the deal.

AeroTechnology sells and services the navigation and communications gear used in planes and jets--avionics--and in the ordinary course of doing business, Probert had learned that an Italian airline had some used avionics equipment on hand.

Probert figured he could buy the gear for $250,000--and he knew he could sell it for $400,000. But like most business owners, he didn't have a quarter mil idling in his bank account.

What to do?

With the help of two astute lending pros, Probert took a crash course in a little-known financing technique called purchase-order borrowing. In short order he raised the capital, did the deal and collected his profit--all in a manner exemplifying the good that this financing technique can do, when properly used.

As described in this space last week, PO financing allows you to borrow against a purchase order just as you borrow against your inventory or receivables, in essence hastening the time it takes to turn these assets into cash.

To understand the technique, it helps to think of your production line as a means by which you turn raw materials into cash. Raw materials become inventory when they reach the end of your production line, and inventory becomes receivables when you ship your goods to a customer. Receivables become cash when your customer pays you.

Put another way, raw materials gain in value through time as they pass down your production line, and the shorter the time, the greater the profit you realize from that value.

Lenders advance working capital against inventory and receivables because they understand their value--classic asset-based borrowing. Business owners borrow against inventory and receivables because they know that the sooner they buy more raw materials, the faster they realize the value created by their production lines, in the form of profit. In a very real sense, asset-based borrowing speeds up the production line.

But if your inventory and receivables hold value, so does a purchase order. In fact, you can borrow against a purchase order just as you borrow against inventory and receivables, with the same effect--that is, hastening the time it takes to turn an asset into cash.

Richard Probert learned about PO borrowing from Larry Hurwitz, whose Brentwood firm, Lawrence Financial Group Inc., arranges debt financing for small and middle-market businesses, and from Tom Novembrino, then a business lender with USBancorp and now a managing director with Transcap Trade Finance, one of the country's biggest purchase-order lenders, with offices in Pasadena.

"I found out about the gear just by nosing around," Probert says. "It wasn't really for sale; the airline just had it in inventory. I sent them a fax asking about it, and because I inquired, they said yes, they did have it. I offered to buy it for $250,000.

"The price for the same equipment if new would have been around $750,000. I called the original manufacturer, Honeywell, and they wanted it for spare parts. They gave me $400,000 for it."

Probert, of course, didn't have the $250,000 on hand, but on the strength of the purchase order from Honeywell, he secured the financing through Hurwitz and Novembrino.

"We put that deal together probably in two or three weeks," Novembrino says. "You have to do your due diligence in these deals; you have to know who's buying and who's selling. But sometimes, if you don't move fast, the deal disappears.

"We had a purchase order from Honeywell for $400,000, and we were advancing $250,000 against that--which was 100% of Richard Probert's costs but well within our own limits against the PO."

Probert's cost of borrowing came to 5 points on the loan, or $12,500, so he netted $137,500 in profit on a $400,000 deal.

That's a nice piece of change, to be sure, but at about 9% of his profit, the fees he paid Hurwitz and Novembrino illustrate both the benefits and dangers of PO financing.

*

Time is your biggest ally and gravest threat in a deal financed by PO borrowing. The technique shortens the time it takes to turn a PO into cash, but it magnifies the consequences of dallying--because, at 2% to 5% per month, the interest costs can eat you alive.

Put another way, if you use PO financing:

* Turn your PO into cash rapidly lest you lose everything to interest costs.

* Don't even think about PO financing unless your gross profit, like Probert's, cushions you against the threat posed by time.

* On the other hand, don't rule out PO financing just because it's expensive.

PO financing allows you to do deals that would otherwise pass you by, just as it gave Probert the chance to make $137,500 in a deal he could not have financed himself. It works when you need working capital to make the most of an unexpected opportunity.

It doesn't work as a means of raising working capital for the ordinary business you do--because it magnifies the threat that comes from losing control.

*

Freelance writer Juan Hovey can be reached at (805) 492-7909 or via e-mail at jhovey@gte.net

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