Opinion: How to Safely Use Debt to Grow Your Business

This Opinion piece appears in the May 9 print edition of Transport Topics. Click here to subscribe today.

By Todd Ehrlich

CEO

BAM Worldwide

Expectations this year are for the U.S. economy to grow moderately, fuel prices to stay at historic lows and truck capacity to remain tight for a healthy rate environment. However, growing faster than the competition will require more than opportunities.

Working capital is needed to purchase assets, hire employees and cover operating costs. Borrowing capital may be necessary as new revenues often take time to catch up with expenses.

Using debt to grow has traditionally been considered high risk and can create long-term liabilities. However, “transactional debt” — a relatively new financial offering — delivers working capital precisely when and where it is needed, in alignment with current and future cash flows, with low risk for all parties involved.

Ehrlich

Many software providers are now using a “pay-as-you-go” subscription model called Software-as-a-Service, or SaaS. This approach does not require contracts to use products and services, which often means paying for features you never use.

Many SaaS applications use a variable pricing model. The cost changes each month depending on the volume of transactions such as the number of loads, trucks, miles or drivers in the system. This structure gives clients visibility and control over costs and closely aligns the services they use to the value they receive.

Transactional debt follows the same approach. Small brokers and carriers gain instant access to funds at a variable cost that depends on the dynamics of each transaction.

Suppose a small freight broker has an opportunity to take on more business from a customer. To get the business, the broker offers the customer 45-day payment terms. To get the capacity it needs to service the account, the broker determines it needs to offer 15-day payment terms to carriers.

The shipper already has a good credit history but the broker does not.

However, if the broker uses a specialty lender with a transactional debt service, the broker is able to guarantee payment to carriers at 15 days to take on the new business.

Central to this arrangement is a web-based platform that streamlines the transaction for all parties involved. The lender’s risk is low by knowing the purpose and status of the transaction. As a result, the lender can offer a low interest rate and transaction fee by having visibility to the funding process from start to finish.

The lender knows the broker is requesting funds to cover loads. And carriers are willing to accept the loads at a competitive rate knowing that payment is guaranteed by a third party. Getting fast acceptance by carriers lowers production costs for the broker.

By using the connectivity platform, lender and broker share visibility of the load as it moves from pickup to delivery. As soon as the carrier submits proof-of-delivery documents, a payment is scheduled according to terms.

Perhaps most importantly, the broker is able to improve its credit rating across its business to ensure future success by covering more loads from customers.

This transactional debt model may sound similar to factoring, but there are key differences.

Factoring companies provide a valuable service to the transportation industry to speed cash flows. Traditionally, factoring works by a carrier or broker selling receivables to a third party at a discount. The factoring company owns the receivables and takes over collections.

Traditionally, a bank or factoring company requires long-term contracts. For instance, a broker may agree to sell 20% of its receivables for a certain time period.

Factoring can cause friction in the funding process. Shippers generally do not like getting invoices or receiving collection calls from a third party. Factoring does not improve the level of trust between brokers and carriers.

The main difference is factoring arrangements do not have visibility to the underlying data of the transaction. Without visibility, factors and traditional lenders charge high fees to protect themselves from unknown risks.

Comparatively, transactional debt that is delivered through a technology platform ensures all parties are protected, lowering risk and costs of funding — and sustaining growth.

By using transactional debt, brokers and carriers are potentially able to attract outside investment to compound their growth opportunities. One of the most important measures that investors use to determine the value of a company is EBITDA (earnings before interest, taxes, depreciation and amortization).

Companies that have a strong EBITDA in relation to their peers are an attractive investment opportunity. For an investor, the interest rate that a broker or carrier is paying for capital it is using to grow is a minor concern. In fact, the investor will likely see this as an opportunity to increase margins by acquiring the company and lowering the cost of capital.

Besides using transactional debt, companies may benefit by using a lump sum. A freight broker, for example, could take out a loan for 90% of its receivables to launch a new division, refinance existing loans or acquire another business, among other possibilities.

In either scenario, companies that use debt to grow must have a clearly defined purpose for funds and be able to assess the impact on their present and future cash flows. The benefit of using transactional debt is that the purpose and the impact on cash flows is known in advance. Lenders specializing in accounts receivable financing can use this visibility at the transaction level to eliminate risks and offer low-cost access to capital to help transportation companies seize growth opportunities next year and beyond.

BAM Worldwide is a financial technology and specialty lender for the transportation industry.