Giving your working capital plan a fresh look

Venture debt investors who typically have greater appetite for lending in higher risk cycles remain a viable — if sometimes pricey — source of financing for certain CFOs. 

While not the right fit in all cases, venture lenders provide an alternative to CFOs who have seen a number of routes to fresh capital narrow amid global economic turmoil this year. Startups or companies with less predictable cash flows often gravitate toward it.

“The venture fund ecosystem is accustomed to risk, is accustomed to changing markets…and so they’re sort of prepared to continue to lend in markets that are uncertain, where more formulaic lenders can’t find the underwriting criteria,” Jennifer Post, a partner in Thompson Coburn law firm’s corporate and securities practice who has worked closely with venture debt funds, said in an interview.

Indeed, the value of publicly announced debt financing rounds raised by venture-capital-backed startups in the U.S. rose to nearly $15.9 billion in 321 deals this year through July. This is compared to $13.3 billion in 320 deals during the same seven-month period last year, according to an Aug. 3 report from Crunchbase News which tracks the data. 

In contrast, mergers and acquisitions (M&A) worldwide slumped 21% during the first half of 2022 compared with the same period last year, according to Refinitiv. Meanwhile, equity volatility and regulatory scrutiny have damped company’s prospects of using special purpose acquisition companies (SPACs) as an exit strategy. 

As funding options shrink, tech firms in particular are eyeing debt funds, according to Efraim Chalamish, an adjunct professor of law at NYU, writing in a July 21 piece for Global Finance magazine. 

“The decline in startup funding globally and the uncertainty around raising new venture funds have brought attention to new sources of capital for technology companies to address liquidity and operational concerns via venture debt financing,” Chalamish wrote. 

Weighing the cost

Finance chiefs considering venture debt should weigh the advantages and disadvantages. Venture debt is typically non-dilutive and funding levels have been rising in recent years, ranging from $2 million up to $50 million and higher, Post said. 

The main drawback is that venture debt tends to be more expensive than commercial loans but the terms are generally more flexible in terms of the amount of debt available and how and when it is deployed to the company, she said. But venture lenders tend to be more partnership oriented, typically making the deal based on a company’s projected milestones, capital raising ability and a variety of metrics versus just looking at a company’s balance sheet. 

“You certainly pay more for the debt capital but in return you get real partnerships from venture lenders and partners who have funded many scaling companies and understand what the choppy waters look like there and how to structure resolutions,” Post said. 

The willingness of venture lenders to work with companies can come in handy if “things get skinny” and a company deviates from a plan because the venture lenders have more leeway than bank lenders have, she said. 

Some of the big name venture debt players include Hercules Capital and Trinity Capital. But Post said she would advise firms to do their homework and research lenders that have deep domain expertise in the company’s sector that would be better equipped to understand a certain patent approach or metric, for example.

“You have to find the right lender,” Post said, noting that some will consider pre-revenue companies. “If they really understand the industry they might be able to take the risk.” 

Transport Corp Canada’s trucking division, RIMS Transport, is still dealing with fallout from the latest supply chain challenges that are gripping the sector but Group CFO Venu Katta has leaned on technology and other cash flow management tactics to ease the pressure on his firm’s bottom line.

“Cash flow management is now something I focus on heavily,” Katta said in an interview. The supply chain chaos that erupted during the first wave of COVID-19 was given new oxygen this year as Russia’s invasion of Ukraine led to a supply-side oil shock and China’s manufacturing activity has contracted amid its zero-Covid policies.

“We’re not getting parts on time, transportation costs are going up, there’s no space in the warehouses, and the demand for drivers is greater than the supply,” Katta said. “We’re still feeling the impacts of the pandemic in this business. We’re still in the process of clearing the first backlog.”

Transport Corp Canada, the largest privately-held trucking enterprise in Southern Ontario, provides transportation and supply chain management solutions in Canada and the U.S.

Desperate for drivers

Part of the early pressure on the trucking sector was tied to a shortage of truck drivers that prompted some companies like Transport to beef up or somehow sweeten compensation.

For example, instead of paying a trucker bi-weekly, Katta began issuing pay checks weekly. He also expanded the company’s group insurance coverage to include truck brokers and owner operators and gave workers rebates on their insurance through its captive insurance program and extended group medical and dental benefits to owner operators and brokers, he said.

“We desperately needed to retain our brokers, drivers and owner operators,” he said. But in order to pay weekly, he needed more cash on hand and the cost of the incentives led Katta to find ways to offset costs by better managing working capital.

One change Katta has made is aimed at getting the company paid faster. He sought to reduce the days sales outstanding (DSO), a measure of the average number of days that it takes for a company to be paid after a sale. The firm’s DSO was getting worse, with collections going from 45 days to 60, leaving the company going through its cash faster than receivables.

It used to take at least three to four business days before the company would start the process of sending out invoices, he explains. Now the company has invested in some technology to address that.

“We had the software system enhanced so that the manifest is scanned on the same day. We gave the brokers, owner operators and our drivers cell phones with scanners and documents that can be sent automatically. That eliminates the step of them filing the papers in the office, and then having to scan it into the system. Now it goes directly from the phone into the software, and then [it’s] invoiced,” he said. 

RIMS Transport had to come up with innovative solutions earlier in the pandemic too, when the shipping lanes between the U.S. and Canadian border came to a virtual stand-still. It was a difficult time for a company largely dependent on trade between the two countries.

Cooked tires

In order to ensure they would have enough drivers to cross the border, RIMS Transport implemented an incentive strategy to make sure all their truckers were vaccinated. “To keep our trucks rolling to the US, we gave $1000 to whoever got the vaccine and paid another $1000 for every booster shot they got,” he said. The result was that 99% of their drivers, owner operators and brokers had vaccine certification, he explains. This also incentivized them to stay with the company during a time when it was hard to get people back to work, he
added.

As to the on-going supply-chain challenge for 2022, as many have predicted, there’s no end in sight but new challenges have emerged that need solving.

For example, tires are in short supply for the transport industry, he explains. “They’re just not available particularly if you’re running eight, 12 or 16 tires per axle trailers, or flatbeds. Most of these are manufactured in Korea China and India, and when they’re held up at ports for a month or two, they get damaged because they’re sitting in a hot container. The material inside the container is cooked.” Repair parts for trailers are also sitting at sea, and also come from countries like China or India. These types of costs can’t be pushed onto the customer, Katta adds.

Few processes are more important than lead-to-cash; it determines your customers' experience when interacting with your company. Yet for many organizations, the process is manual, full of bottlenecks, and generates often untrustworthy siloed data, lead-to-cash experts say.

With their unique vantage point, CFOs are well-positioned to lead the process transformation, Derik Quinn, managing director at Huron ES&A, said in a has said.

“Customers want a frictionless process,” he said. “This means, from the very first touch point that customers have with your company all the way through to them making a purchase and becoming a customer, they ultimately want that experience to be as frictionless as possible.” 

Understanding lead-to-cash is especially important if your company is transforming, or is planning to transform, from a transactional to a recurring revenue model, because the success of that model is dependent on positive engagement with the customer over time. “It’s not just a one-and-done transaction,” he said.  

CFOs who get the process right can shorten the close cycle, improve forecasting and reporting, improve collaboration with other units in the organization, more consistently apply regulatory changes, and pave the way for automation of slow, manual, error-prone processes, he said.   

Creating a seamless process

For many companies, lead-to-cash is an overly manual process, a CFO.com survey of 150 executives found. There are other problems:

• Misalignment between what sales staff are doing and what finance wants
• Poor visibility into future revenue
• Slow handoff between sales and finance

“What ends up happening,” said Ian Dunckel, director at Salesforce CPQ & Billing, “a department or group that sits in between sales and finance is manually generating quotes out of Excel and running them by finance to make sure it’s not breaking any revenue recognition rules and the pricing’s right and isn’t discounting any single line item more than is allowed.”

Despite the problems in a system like this, executives often prefer to keep the status quo because they don’t want to make it harder for the sales team to generate new business. 

Dunckel said he hears from executives who say, “‘I want to keep it wild, wild west’” on sales. “‘I want [sales] to be able to do whatever they want.’”

But that creates back-end problems, he said, because sales will give customers discounts, or a customized mix of products, different payment terms, or they’ll sell an outdated product or sell to customers the company isn’t targeting from a strategic perspective.

For the finance team, when deals come in like this, it’s hard to treat them as revenue. “I can’t book the deal that sales is closing, but maybe I still have to pay them for it,” he said. 

Putting in guardrails

By transforming this process—moving to a system that manages lead-to-cash on an end-to-end basis—you improve the customer experience, speed processing (in part by automating those parts for which rules can be written), create “guardrails” around which deals that can be recognized as revenue, and generate data for better understanding the market and tweaking your products and processes, said Amit Patel, managing director of Huron ES&A. 

“This goes back to the customer experience,” said Dunckel. “If they say they want to buy something, it shouldn’t take two weeks to turn that around. But these guard rails also protect finance against over-discounting, changing payment terms, selling the wrong products together or selling into markets that we don’t necessarily support or currencies we don’t necessarily support.”

Given the importance to finance that all the departments with a role in the process work together, it’s appropriate for the CFO to see the transformation as within its role. 

“Finance doesn’t see it as part of their domain but it absolutely is and one of the first areas of partnership is between sales and finance,” Dunckel said.

Short-term goals that can make a difference in your growth should include short-term funding rather than expensive, long-term debt or equity capital, revenue-based financing specialists say. 

An ecommerce or retail company that’s trying to boost inventory before a key sales event, for example, should use cheap, short-cycle funding that doesn’t leave the company with an overhanging obligation. 

“What we’re saying is, rather than use super-expensive equity, or other options … where you’re investing in something that’s short term, use a more efficient source of capital,” says Asher Ismail, co-founder of online-based lender Uncapped.

Ismail, whose company specializes in ecommerce startups, says getting traditional debt and equity funds can take too long for companies that need to act quickly to capitalize on a short-term event that can help them scale. 

“It’s different from when you sit in the bank branch and try to talk about a business plan, or try to pitch to venture capitalists,” Ismail said in a 2X eCommerce podcast. “You have endless meetings without necessarily knowing what’s happening.”

A key example is marketing, Ismail said. “If you put £1 into Facebook, and you know you’re going to get £3 back, it doesn’t make sense to give away really costly equity to fund that,” he said. 

Financing space

Uncapped, launched in London in 2019 with operations in the United States, is one of the newer lenders to compete in the revenue-based financing space. Models in the space differ, but they tend to share a core feature: borrowers’ repayments are tied to monthly revenue performance; if revenues rise, so do payments; if they decline, payments decline, too. That gives a measure of comfort to companies that, if they make a strategic mistake that causes their revenues to fall, they don’t necessarily have to face default as a result.

“Because you’re paying a variable on a monthly basis at a percentage of your gross cash receipts, there’s no way for you to default on a payment,” Carlos Antequera, CEO of Novel Capital, told CFO Dive. “Because your payment gets calculated as a percentage of what you get in cash, there’s not a fixed payment that you’re going to miss.”

Novel focuses on software-as-a service (SaaS) companies that generate recurring revenue or a mix of recurring and non-recurring revenue.  

Lenders in the space also tend to share other business practices, including limited, if any, covenants, and direct access to the loan applicant’s accounting software so they can base their underwriting decisions on real-time business data the company is generating. 

“We connect to the data sources that the business already uses to run,” said Ismail. 

Since Uncapped’s borrowers operate in the ecommerce space, that means his company taps into, in addition to their accounting software, their Shopify and Google AdWords accounts, and other similar platforms. 

“We build a 360 degree view off the back of that to make a data-driven decision in 24 hours,” said Ismail. 

Higher valuations

Companies hoping to go out with a major capital raise in another year or so might find the financing a way to make operational investments that will enable them to seek a higher valuation when they finally reach out to investors, Antequera said.

About a year ago, Novel worked with a startup that wanted to boost its sales team before pursuing its first non-venture capital raise. It used the short-term loan to hire a sales chief and build a team under that person.  

“With COVID-19, their product just took off,” he said. “They were able to raise a very large Series A on that really good valuation. Those 18 months helped them get in a really good position while they retained ownership. [The CEO] was able to show much better metric for that next round.”

One of Uncapped’s first customers was sustainable fashion brand Hedoine. Like a lot of new ecommerce companies, Ismail said, their growth was hemmed in by limitations on their revenue. They juggled their cash between marketing and inventory, forcing them to wait until they sold out their inventory before they could invest in the upcoming season’s fashions.

“They looked at venture capital, venture debt, but wanted something more affordable,” said Ismail. “They signed up for a £50,000 advance at the end of 2019 and used those funds to increase their inventory. With these new funds, in Q1, their revenues grew 11,000% compared to the previous year.” 

Whatever niche they’re operating in, revenue-based lenders tend to look for companies with recurring revenue because it's predictable, sustainable and repeatable, enabling them to underwrite quickly and without having to impose onerous performance covenants.

“Looking at the predictable revenue from your subscriptions … is how we gain that level of comfort,” even for companies that have a mix of recurring and non-recurring revenue, said Antequera. 

Novel limits loans to 30% of the borrower’s annual revenue with a monthly revenue share of between 4% and 10%, depending on the size of the loan and other factors. Uncapped charges a fixed 6% on a daily basis with no application or other fees.  

“If you wanted £100,000, we would take back a fixed portion of your daily revenue,” said Ismail, whose company operates in nine countries, including the United States and Canada. “It might be 5% or 10%, until we get £106,000 back.”

CFOs seeking to navigate a shifting economic enviornment are reconsidering their supply chain models as inflationary and other such pressures linger, according to a recent study released by global consulting firm Protiviti.  

Forty-five percent of CFOs and VPs of finance stated they are moving away form efficiency-based supply chain models to revenue assurance models with more flexibility and resilience, the study of 1,064 CFOs, VPs, directors and managers of finance found. The shift, “however long-term or temporary, appears to result from the “out-of-stock” dynamic experienced in a number of industries due to supply chain failures and impediments during the height of the pandemic and thereafter,” Chris Wright, managing director and global leader of Protiviti’s business performance improvement practice wrote in an email.

“A lot of just-in-time inventory models became out-of-time inventory realities, and while there are substantial working capital implications to building safety stock, there are many organizations who have chosen to do so in order to be able to serve their customers and clients,” he wrote.

CFOs are left contemplating changes to their supply chains as they attempt to navigate shifting economic trends; factors such as the ongoing war in Ukraine and the lingering impacts of the pandemic as well as inflation have continued to throw up stumbling blocks for organizations across their supply chains.

The study found 72% of respondents said their companies had experienced disruptions or delays due to supply chain challenges, inflation’s effect on third-party vendors, and ongoing pandemic-related issues, for example.

Financial executives are taking various steps to address these challenges, with 45% of CFOs and VPs of finance noting they are transitioning away from efficient supply chain models to revenue assurance models, for example. Companies will likely put such models to the test next year as supply and demand begins to balance, Wright wrote.

“Over the next 12 months, or perhaps even over a shorter time horizon, there will likely be a fair amount of reality testing of the new approaches, as the supply and demand dynamics will start to balance, and a number of organizations will see how well they forecasted both,” he wrote in an email.

Financial executives are also keeping a close eye on inflation. The survey —conducted between June and July 2022, when inflation in areas such as consumer prices had slowed somewhat — found 69% of CFOs indicated addressing the impact of inflation was a top priority. Comparatively, 72% of VPs of finance or non-CFO executives pointed to inflation’s impact as a top priority.

“Largely, the inflation dynamic is immediately impacting CFOs in the FP&A area — they need to be able to forecast costs in order to re-align revenue and margin models (if they can pass those costs along, if they can’t), and also understand how that affects their companies broadly in the market,” Wright said in an email regarding how CFOs are considering inflation.

Perhaps in light of lingering supply chain challenges, many CFOs are also reassessing the potential of emerging technologies at their organizations, as well as taking a second look at their data privacy and security practices.

Seventy-two percent of survey respondents stated blockchain and smart contracts were a top priority for their businesses, compared to the 68% who said the same in the prior year, per the study. Automation, meanwhile — a new category not present during the 2021 study — was cited as a top priority by 72% of both CFOs and VPs of finance.  

“The blockchain uptick can be seen as an indication that this technology allows for solutions to two CFO imperatives: supply chain visibility in general, and sustainable supply chain/ESG visibility in particular,” Wright said in an email regarding the spike in interest in emerging technologies. “Automation tech is driven by the need to streamline processes, adapt permanently to lessons learned while working remotely, and allow the finance teams to focus on analysis, rather than generation, of data.”

Both CFOs and other financial executives listed data privacy and security as their top priority for the next 12 months, with 73% of survey respondents indicating this was the case for their organizations over that period.

However, while security topped this year’s list of priorities, the 73% of executives citing it as their main concern this year is slightly lower than the 83% who did so in 2021 — a downward trend potentially indicating CFOs are gaining better control over this space, according to the study.

CFOs and other financial leaders should take care not to become complacent in their security efforts, warned the study, but should instead take steps to lead discussions surrounding cybersecurity. This includes helping their companies’ data privacy leaders connect their own activities to business objectives, per the study.   

As CFOs battle rising costs across nearly all fronts, litigation finance can offer an alternative means of holding legal expenses down. Now a roughly $17 billion business, the process typically entails an outside party unrelated to a lawsuit providing capital to help a company cover legal costs in exchange for a future portion of the settlement.

It can mean costly tradeoffs: funders can seek returns of three to four times what they give companies if a company wins a judgment. If a portfolio of cases is involved, amounts can rival high-interest loans.

Still, proponents say, it helps companies pursue litigation without denting liquidity. To learn more, Industry Dive sister publications CFO Dive and Legal Dive spoke with Gary Barnett, executive director of the International Legal Finance Association, ahead of the group’s annual conference in New York next month. The following Q&A is edited for clarity. 

Industry Dive: Litigation financing has been around for two decades. Why do you think it’s taken off in recent years?

Gary Barnett: In the U.K. and other places there are judicial decisions that reaffirm the benefits of the funding. That obviously is beneficial when courts are commenting on the benefits. In Switzerland, for example, there is a requirement that you inform the parties of the existence of legal finance. But generally speaking, as the industry grows and more people learn about it, that is [helping to generate] steady growth of the industry.

Industry Dive: In terms of users, are they mainly larger or smaller companies?

Gary Barnett: I would say it’s both. There are large companies that recognize there are benefits to using legal finance and keeping capital, which can be used to grow their business. And there are smaller companies whose capital is more precious that need to find innovative ways to avoid eating into their cash.

Industry Dive: From a CFO perspective, what are the advantages of working with a funder?

Gary Barnett: It increases liquidity and reduces expenses. Unless you are financing your affirmative recovery program, you are incurring costs and incurring costs potentially over a long period of time, so instead of using your own cash flow to fund these cases, by using legal finance you are able to keep that cash in your company.

Industry Dive: Litigation finance is seen as a way to pay for litigation but how do you respond to concerns about it fostering frivolous lawsuits?

Gary Barnett: Generally providing the means for companies to pursue a meritorious claim I consider to be a good thing. That allows laws to be upheld and bad actors to be held accountable. Some suggest that this leads to bringing cases that might be weak claims or not meritorious, but I think a legal finance provider that is funding non-meritorious cases would not be in business for very long. They’re providing capital on a non-recourse basis over a long period of time. And so they have to be rational actors. They have to be highly selective in the cases that they choose or they risk losing all their capital.

Industry Dive: From the counsel perspective, is there a trade-off that a company cedes in terms of strategy or control of a funded case?

Gary Barnett: Companies don’t give up control because litigation funders are passive providers of capital. They’re there to potentially provide some strategic advice on budgeting issues but they don’t stand in the shoes of a client and they don’t control the litigation strategy.

Industry Dive: Are there any guarantees written into contracts on that?

Gary Barnett: Legal ethics rules in the U.S. especially do not allow anybody to get in between the client and the lawyer. Our members are keen to ensure they are not going to violate those rules.

Industry Dive: How does a litigation finance deal typically evolve? Does the general counsel pick up the phone and call a funder to see if they’re interested?

Gary Barnett: I think it comes from all different directions. There are relationships that companies have with particular legal finance providers and so they will go to them if they have a particular matter. Legal finance providers are also interested in engaging with general counsels (GCs) and CFOs and trying to increase awareness of the benefits of legal finance. Deals also come from law firms that either suggest it to the corporation or they reach out to a finance provider to see if financing makes sense.

Industry Dive: What is the timing of such an agreement?

Gary Barnett: It can happen at the beginning of the case or it can come in post-judgment, and so it can really happen anywhere along the line.

Industry Dive: There’s this perception of secrecy or lack of disclosure around the industry. How do you respond to that?

Gary Barnett: It’s important that we are transparent with the clients and forthcoming with any requests from the courts. Both of those principles are embodied in our best practices that our members agree to follow but it’s not a simple issue. Judges already have the authority to request disclosure in the courtrooms and we see judges use this when they deem it to be relevant.

Industry Dive: In the U.K., in certain types of claims they have to disclose the presence of a litigation funder because they need to show they can pay damages. Do you see a day when there will be full disclosure in other courts?

Gary Barnett: We’re concerned about the distraction that would cause. Courts are using their authority if they think there’s an issue in a case. It’s important that we be careful in what we are being forced to disclose.

Industry Dive: Are there any defense-side litigation funding products?

Gary Barnett: Yes, defense side cases are something that is being funded in certain circumstances. It’s done mainly in portfolio investments where there is a portfolio of cases, both affirmative and defense. It’s definitely something the industry is focused on.

Industry Dive: Given the current uncertainty in the economy, is more money flowing into litigation finance now?

Gary Barnett: It’s a non-correlated asset, so I think that is obviously something of interest to investors. Obviously the economy is changing every day and we’ll see which way it goes and what the impact will be. And will it be for the better on the investment side or will it be for the better on the user side is really the question. We argue, both.

Industry Dive: What are the main questions that are on the minds of participants in the industry right now?

Gary Barnett: It’s the future of the industry and where it’s headed. The impact of the economy on the industry is also something else that’s being discussed. And then how to grow the industry as well as continue to educate relevant stakeholders.