Tapping into Smart Finance

At a time when the IT industry is transforming and the economic scenario is not so exciting, the IT channel must leverage several financing options to fund their business as well as their customer’s business

By Amit Singh

For almost half a decade, IT experts and the Indian IT channel have been advocating the need for cultivating a business that sells and delivers technology services on a recurring revenue basis. The reason is the predictability which repeat revenue brings to the business.

The past 2-3 years have been tough on IT channels. Apart from the rapid transformation which the technology industry is going through, the domestic market has gone through the dual jolt of demonetization and Goods and Services Tax (GST). While during the past two decades IT channels grew along with the industry, most partners are now struggling to keep their top lines and bottom lines growing.

In addition, inflationary trends have impacted the IT industry, and the cost of operations has almost doubled over the 5-7 years.

However, leaving behind the adverse impact of demonetization and GST, industrial production is improving since November 2017. GST and demonetization impact is slowly fading away. As per World Bank’s latest Bi-annual South Asia Economic Focus report the Indian economy has recovered from the adverse impacts of demonetization and GST and is projected to grow by 7.3 percent in 2018 and 7.5 percent in 2019.

In this scenario, channels of all sizes and strengths are looking for newer ways to fund their growth. In an industry where a larger chunk of players is first time entrepreneurs, growth is a huge challenge because of the lack of capital.

Changing market dynamics

Over the last few decades, partners have built robust businesses on top of distributor and vendor credit. In a market that was growing fast and where margins were healthy, this business model worked well. “However, that is not the case anymore,” points out Jayessh Mehta, Managing Director, Future Businesstech. “Today, we prefer to walk away from transactions because the margins do not cover even a finance cost opportunity of 2 percent a month when customers push payments to 60 days and above.”

While the dynamics of the IT industry are now changing towards solution selling, payment term with the customers has become a major challenge. “Most of the sales pitches are now driven by application-led solutions to enhance the business operations and to drive the RoI. While solution selling tends to increase the margins in many of the cases, it has also resulted in customers negotiating for extended payment terms of 90 days to up to 4-5 months,” retorts Prarthana Gupta, Managing Director, Cache Technologies.

The extended payment term leads partners to either block their working capital or resort to funding from external sources. “We prefer not to use external funding and tend to move out of the deals which are beyond our financial limits. Most of the time, we are able to negotiate a deal with payment terms in tandem with credit period offered by distributors and vendors,” says Ajit Mital, Managing Director, Acme Digitek.

Harshavardhan Kathaley, Director, Partner Sales, India & Saarc, Juniper, recommends negotiating better payment terms with the customers. “Try to get 80 percent of the payment on delivery of the product itself rather than linking entire deal payment to installation and implementation. This way partners can maintain a good flow of money.”

In the majority of the cases partners rely on credit period from distributors and vendors, which is normally in the range of 30 days to 45 days. In few cases, the credit period is extended to up to 90 days based on the merits of the transaction and credibility of partner and the customer. “Relationship and payment credibility with the distributors pays well in this case. In fact, this is the best way to save our margins. We opt for external funding in cases where credit period and payment terms don’t match and margins are handsome enough to accommodate additional burden from interest rates on loan,” informs Mehta of Future Businesstech.

Cost of finance

The cost of finance and the complications associated with it have discouraged a number of partners from expanding. “There are very few risk-takers in our industry,” comments Gupta of Cache. “Many are wary of taking loans, and want to work within the limits of the credit extended by suppliers.”

Others point out some unpleasant realities. “The margins in the business should correlate with the cost of finance. I believe that for healthy growth the average margins should be a few times of the cost of finance. Regrettably, that’s not the case in most systems integration transactions and projects. This is the reason most of us are dependent on vendor and distribution credit,” remarks Mital of Acme.

Many in the industry point out that there is a significant difference in the cost of finance depending on the players – it skews unfavorably for the smaller channel partners.

“While most established players enjoy bank interest rates which vary from 8-16 percent, smaller players are offered loans at 18-36 percent. Since the margins are not so great the equations are unfavorable for smaller partners,” explains Gupta of Cache.

Others insist that it is a matter of educating channel partners about smarter options. In fact, Rohit Midha, Director, Commercial Named Accounts, Lenovo India, is a big advocate of learning from other industries. He says it is time IT channels start learning from the automobile and consumer durable industries which thrive on smart financing options. “In the past channels have been wary of exploring funding options because they never had to. Today that is not the case. I believe every vendor has been asking channels to consider all financing options to fund their business as well as their customers’ businesses.”

Vendor finance

Almost all major vendors including HP, IBM, Cisco, Dell EMC have their financing arms operating in the country. These arms are keen to work with channels to fund quality customer business.

This is where industry pundits have been telling IT channels to follow automobile industry. Though a majority of auto customers are consumers, almost the whole automobile industry sells its products with finance options.

While almost all vendors have been operating for a long time with their financing arms, a sense of aggression has crept in only a few years back. While earlier these companies were strict about funding only those orders where 70 percent of the bill of materials were their own brands, in many deals the vendors have relaxed the norms.

“In some cases, we have seen vendors like Cisco funding customers where Cisco component has been as low as 35 percent,” shares Rajiv Kumar, Managing Director, Proactive Data Systems.

The loans are offered to the customer; for a partner, the money is usually credited within a week of successfully completing the project.

Financing arms of the vendors are able to offer better rates as compared to banks because their risk coverage on a loan for their product line is lesser than that of a traditional NBFC. Most of the vendors have policies on used equipment and leasing arms which can find a customer for used equipment. This helps the leasing arms to offer loans at 8-10 percent.

“In addition, as with loan for a high-end car, where the loans can be restructured to show that interest rates are lower than the actual through rebates issued by the automobile company to the financing company, vendors are able to present attractive financing options,” elaborates Kartik Shahani, Director and Leader Security, India and South Asia, IBM.

However, there are challenges from customers’ willingness to take a loan. “Vendor finance is the most lucrative option for channels as the loan is taken by the customer at quite low interest rates. However, only 15-20 percent customers are inclined towards taking a loan. Most of them want to make payments after 60-90 days credit period,” informs Gupta of Cache.

On the flip side, the financing arms of the vendors are usually risk-averse and seek to finance smaller partners only with collaterals like bank guarantees, adds Kathaley of Juniper.

Channel finance

Channel funding, also called bill discounting, is a quite popular option and is of two types: purchase bill discounting and sales bill discounting. Purchase bill discounting is a finance option usually recommended by distributors. It essentially allows partners to raise finance against the invoice or bill of IT products purchased from a distributor or supplier.

Sales bill discounting (also called factoring) allows companies to raise funds based on credentials of their customers. Financial assistance up to the value of the invoice of the goods supplied to a customer is provided by the lending financial entity; the market reputation of the customer is of prime importance for availing this loan.

In both cases, the credential of the partner is also very important. Most of the paperwork around purchase bill discounting is standard, and it is not different from any other loan. Apart from regular papers for risk approval for the bank, originals of the purchase bill and a letter of recommendation from the distributor are mandatory. The usual loan period is between 30 and 180 days. Purchase bill discounting interest rates are often 2-3 percent above normal banking interest rates. “We prefer it against the bank loan as purchase bill discounting is easier to secure and offers flexibility in loan payments. Interest rates also vary as per our credibility and relationship with the distributor or the vendor,” says Mehta of Future Businesstech.

Further, there is intense competition among banks and NBFCs to do channel financing, and many sub-distributors say their average annual interest payment is now as low as 11-12 percent. Some of the partners even use purchase bill discounting to make an immediate payment and avail cash discounts, which are often above 2 percent pre-negotiated with the vendor and distributor, and which could be lower than the interest paid out during 30 or 60 days of financing.

“Many partners use a bill discounting loan of 40-50 percent of the bill value as a short-term fund made available for a period of 30 days. This provides them with an extra month to manage the cash flow and collections. This is an excellent way to manage cash flow in case of delay in payments,” explains Gupta of Cache.

Factoring involves an interest rate which is about 12-14 percent for an established partner addressing a well-known business entity. Factoring is one of the best models whereby you readily convert credit payables to immediate cash.

In fact, few of the partners readily use bill discounting from vendors to maintain optimum cash flow. “We indeed utilize bill discounting in almost all transactions with Cisco as we are billed directly in Singapore where interest rates are quite low at just 2-3 percent. This allows us to maintain liquidity inside the organization,” informs Kumar of Proactive.

The company has recently bagged a project worth Rs 5 crore from a large PSU where the payments are made on a monthly basis over a period of 5 years.

Project finance

While sales and purchase bill discounting are excellent options for short-term funding, for long-term projects where the gestation periods and payment cycles are longer than four months, it is important to look at alternative funding models.

In addition, many of these projects often run into multi-million dollars where both partners and distributors face credit issues from the vendors. “One of the reasons why vendors and even customers prefer national system integrators like Wipro or TCS to execute large orders despite better value being offered by some of the smaller SIs is their ability to finance the orders,” explains Mital of Acme Digitek.

To work around this many value-added distributors have come up with a model whereby the customer, partner, distributor and in some cases the vendor agree on a multi-party agreement and form an escrow account where the customer remits payments against different bills submitted as per the contract. The bank then makes remittances as per the contract with fixed percentages to the partner, distributor, and vendor.

“This is one of the safest models where the OEM is assured of payment while partners and distributors do not have the risk of funding the payment. Most large banks have templatized contracts, and if the customer can be convinced, an escrow account and a contract can be made within a couple of business days,” shares Kumar of Proactive.

He adds that for partners, this is a great option. “A tripartite agreement with payment to an escrow account allows the deal to be treated differently and ensures that our credit lines are not choked. We have executed several high profile orders over the past few years using this model.”

Proactive has formed a commercial estimation team which looks into the best funding option and incorporates the financing costs in the project costing at the beginning itself.

While banks and NBFCs offer project finance, many partners have availed them for internal projects and not for funding projects executed for the customers. This is because the margins in many cases do not allow a partner to fund the project using standard long-term financing models. “Project financing is a long-term commitment and if the partner is not having enough funding resource at a lower interest rate, it is just not advisable to opt for any regular finance model. Rarely are the margins for a partner in excess of single digits, and that would not cover the interest value of more than 7-8 months,” explains Krishna Choudhary, Director, Rashi Peripherals.

According to experts, project finance through banks and NBFCs may make sense if you are executing a large service contract where margins are in excess of 40 percent since these loans are structured for 3-5 years.

Road ahead

The road ahead for the channels is not going to be easy unless they are able to significantly grow both the working capital and the investments in their company. The market dynamics towards digital transformation and solutions-selling has made it imperative for channels to be smart enough in financial management.

As the community progresses, it is crucial that each partner starts exploring smarter financing options too.

Seven Tips to Impress Bankers

Banks offer both term loans and overdraft facilities, which businesses can use to increase their working capital.

Here are certain best practices which partners can employ to get best results through regular banking channels:

• Many small businesses do not show profits or show less profit to pay lower income tax. If you need to impress bankers as well as potential investors, accurate balance sheets, and proper income tax returns help.
• A healthy average quarterly balance helps businesses with proven track records to obtain unsecured loans or overdraft facilities without collateral. Typically, banks are willing to take a risk of up to three times the average quarterly balance for unsecured loans or overdraft sanctions. There are partners who have managed to get 5-6 times their quarterly balance as overdraft facilities.
• Similarly, fixed assets such as real estate can be judiciously used to get an overdraft facility which is 1.5-3 times the market value of the collateral. Real estate rates are always going up, so remember to negotiate on the credit approvals and quantum of sanctions every year.
• Bankers and NBFCs are impressed with purchase orders, contracts, authorized partnership agreements and other documents which help prove your credibility. While these documents alone can’t fetch you a loan, they will boost your chances of getting a loan at perhaps lower than the market interest rate.
• Take extra care to maintain a healthy bank statement for at least 6 months prior to a loan request. Avoid cheque dishonors at any cost.
• Get the company approved by different credit rating agencies. Consumer ratings by CIBIL of directors and promoters also help in impressing bankers.
• Finally, remember that banking is a relationship business that works both ways; hence, form a strong relationship with the senior staff of the bank.