Monday, October 24, 2011

A Comment on Seller Marketing

I've been waiting for several weeks for the conditions to materialize that will allow me to comment on a new TRE risk-mitigation program. We're not there yet, so I still can't write about that initiative.

But, as I wait, the issues of risk and appropriate pricing are still at the top of my list and there was a trigger for comment on those topics last week.

An article, written by a senior officer of TRE, appeared in an industrial trade magazine published last week. The article was a marketing piece setting out a variety of reasons why owners of manufacturing concerns should consider an alternative financing facility like TRE.

The points made in favor of an alternative working capital facility were familiar and predictable to anyone with involvement in or knowledge of TRE. One of them, however, seemed to me to be overemphasized and not completely accurate.

The point was discussed under the heading: "Avoid Personal Guarantees". The discussion began with a comment on the typical working capital provider's requirement of a personal guarantee and of the potential impact on a business owner in the event of a default if a personal guarantee has been provided.

A fair enough comment.

But then the point is made that TRE does not require personal guarantees "because investors who are bidding for your receivables assess their risk based primarily on the credit rating of your customers, not your rating."

The author appropriately points out the obligation of the business to repurchase defaulted invoices but closes with the statement: "Most owners would rather assume this obligation than risk losing their house or savings because of a personal guarantee."

This emphasis is troubling in several respects:

1. In a post entitled "Pardon the Interruption" published June 28, 2011, I argued for the adoption of at least a contingent personal guarantee. At that time I suggested that it be contingent on the posting of non-conforming invoices for sale. That's not the only approach, of course. Such a contingent guarantee could also be triggered by a fraud test. But nothing has happened since June 28 that changes my opinion on that issue. If anything, I am more convinced than ever that TRE will eventually HAVE to move in that direction.

2. Speaking only as one Buyer I can say without hesitation that our buying decisions are not "based primarily on the credit rating of your (the Seller's) customers". The invoice verification process used by TRE does not allow that level of confidence. The uncertainty caused by that process is not an issue of Debtor strength but of confidence in the validity of the invoice. It does not matter if the Debtor is the most creditworthy company on earth. If the invoice is defective it won't get paid. So, the most important question to be asked is NOT whether the Debtor can pay the invoice, it is whether the Seller can pay it if the Debtor does not.

3. Selling the TRE facility on the basis of limited Seller risk is like throwing blood in a shark tank. It's an irresistible attraction to the Sellers that are most likely to become problems. Obviously those business owners; and they are out there; who are just crooks, will find the situation tempting. They don't even have to negotiate to get a personal guarantee requirement waived. It's not even a point of discussion. But even owners who are generally trustworthy can be tempted to act badly when the pressure gets strong enough. And in this economic environment, a lot of them are under pressure.

4. The tension between the sales and risk control functions that is felt in all credit-market institutions is heightened when so much is riding on volume growth. In the case of most banks, for example, there is a counter-force to be found in the requirements for public disclosure. If the credit metrics begin to move in the wrong direction, that will become apparent relatively quickly. That is not the case with TRE. Little data about auction performance is made available publicly and so the pressure on the sales and marketing functions from that source is largely absent. We have to rely on senior management to appropriately balance the growth objectives with a robust risk control environment.

The success of the TRE sales and marketing functions is in the best interest of all of us who are involved in the TRE enterprise. But it is only in our best interest to the extent that it is achieved in the context of effective control of risk and appropriate pricing of risk.

Emphasizing the limitation of owner liability in marketing efforts is, in my view, a dangerous approach to business building that is clearly tempting in the short term but is likely to be counter-productive in the long term.

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