Chapter 6 - Export Financing

Few would disagree that small businesses must look overseas for profit opportunities in the 1990s. However, to compete successfully, small firms must offer financing arrangements that are competitive with exporters of other nations. This chapter will discuss three major influences on an exporter's ability to arrange competitive financing:

• today's banking environment
• how to approach a lender
• methods of payment

UNDERSTANDING THE BANKING ENVIRONMENT

In the United States, most small firms turn first to their local banks for export finance assistance. However, during the past decade many banks have decided not to focus on export financing. The banks' reasons for doing so have varied -- many cut their international operations due to the huge losses they incurred on overseas debt; others may have chosen to concentrate on more lucrative lines of business, such as home equity loans or mergers and acquisitions.

Consequently, during the 1980s export finance expertise in many U.S. banks deteriorated. Even today, most smaller banks do not retain any staff with expertise in international trade. This is not to say, however, that such help is unavailable -- only that small businesses must be persistent and tenacious in their efforts to find it. For example, if a small business loan officer is unwilling to work with his or her bank's international staff (or the bank is unwilling to work with a correspondent), exporters should consider establishing a second banking relationship or, if necessary, moving all their accounts to a more aggressive lender. Don't be afraid to shop.

Given the difficulty most small business exporters face when seeking financing, it is imperative that financial arrangements be made in advance. Finding a lender willing to consider such a request requires that the borrower ensure that the purpose of the loan makes sense for the business, and that the request is a reasonable amount. Prospective borrowers also should understand some key distinctions before beginning discussions with a lender.

HOW TO APPROACH YOUR LENDER FOR EXPORT FINANCING

Venture Capitalists and Lenders

Before approaching a bank for financial assistance, small exporters should understand the distinction between venture capitalists and lenders. Venture capitalists invest in a business with the expectation that as the business grows, their equity in the business will grow exponentially. On the other hand, lenders are not in the venture capital business -- they make their money on the difference between the rate at which they borrow money and the rate at which they lend to their customers. International Trade Services and Export Lending

Small exporters should also understand the distinction between international trade services and international trade lending. Although many banks offer international trade services, such as advising and negotiating letters of credit, the banks' international divisions are not authorized to lend money. International lenders, on the other hand, have the authority to make loans, as well as provide related services. Exporters should verify that the bank officer with whom they are dealing has the authority to lend for an export transaction.

Working Capital Financing and Trade Financing

It is also important to note the difference between general working capital financing and trade financing. A small firm's ability to qualify for general working capital financing depends on, among other things, the strength of its balance sheet and its prospects for generating sufficient earnings over the life of a loan to repay it. Trade finance, on the other hand, generally refers to financing individual transactions (or a series of like transactions). In addition, trade finance loans are often self-liquidating -- that is, the lending bank stipulates that all sales proceeds are to be collected by it, and then applies the proceeds to pay down the loan. The remainder is credited to the account of the borrower.

The self-liquidating feature of trade finance is critical to many small, undercapitalized businesses. Lenders who may otherwise have reached their lending limits for such businesses may nevertheless finance individual export sales, if the lenders are assured that the loan proceeds will be used solely for pre-export production; and any export sale proceeds will first be collected by them before the balance is passed on to the exporter. Given the extent of control lenders can exercise over such transactions and the existence of guaranteed payment mechanisms unique to -- or established for -- international trade, trade finance can be less risky for lenders than general working capital loans.

Pre-export, Accounts Receivable and Market Development Financing

Exporters should understand the distinctions between the various types of trade finance. Most small businesses need pre-export financing to help with the expense of gearing up for a particular export sale. Loan proceeds are commonly used to pay for labor and materials or to acquire inventory for export sales. Others may be interested in foreign accounts receivable financing. In that case, exporters can borrow from their banks an amount based on the volume and quality of such accounts receivable. Although banks rarely lend 100 percent of the value of the accounts receivable, many will advance up to 80 percent of the value of qualified accounts. Foreign credit insurance (such as Eximbank's Export Credit Insurance Program) is often used to enhance the quality of such accounts.

Financing for foreign market development activities, such as participation in overseas trade missions or trade shows, is often difficult for small businesses to arrange. Most banks are reluctant to finance such activities because, for many small firms, their ability to repay such loans depends on their success in consummating sales while on a mission -- prospects that in many cases are speculative. Although difficult for many small firms to do, the recommended source for financing such activities is through the working capital of the firm or, in certain cases, through the use of personal credit cards. Finally, take time to make sure your banker understands your business and products. Have a detailed export plan ready and, most important, be able to clearly show how and when a loan will be repaid.

METHODS USED TO FINANCE EXPORTS

A small business exporter's principal concern should be to ensure that he or she will be paid in full and on time. Foreign buyers may have concerns as well, including uncertainty that the goods ordered will meet the necessary specifications and arrive in a timely manner. As a result, it is imperative that the terms of payment be agreed upon in advance and in a manner satisfactory to both parties.

The payment method exporters use can significantly affect the financial risk of a particular export sale. In general, the more generous the sales terms are to a foreign buyer, the greater the risk to the exporter. The primary methods of payment for international transactions, ranked in order of most secure to the exporter to least secure, include:

• payment in advance
• letters of credit
• documentary collections (drafts)
• consignment
• open account

Payment in advance

Paying in advance is often too expensive and risky for foreign buyers. Yet, this method of payment is not uncommon. Requiring full payment in advance may cause lost sales to a foreign (or even another domestic) competitor who is able to offer more attractive payment terms. In some cases, however, where the manufacturing process is specialized, lengthy or capital-intensive, it may be reasonable to insist upon partial payment in advance, or on progress payments.

Letters of Credit (LC)

A letter of credit is an internationally recognized instrument issued by a bank on behalf of its client, the purchaser. The LC actually represents the bank's guarantee to pay the seller, provided the conditions specified on it are fulfilled. Of course, the purchaser pays its bank a fee to render this service.

The rationale behind the use of an LC is reliance by the seller on the credit worthiness of the bank, which is normally more reliable than that of the purchaser. It is also easier to verify by the seller's bank. Moreover, this vehicle can be structured to protect the purchaser because no payment obligation arises until the goods have been satisfactorily delivered as promised.

The conditions of the LC are spelled out on the LC itself. When the conditions of delivery have been satisfied (usually by the documented, satisfactory and timely delivery of the goods), the purchaser's bank makes the required payment directly to the seller's bank in accordance with the terms of payment (in 15, 30, 60 or 90 days, whichever is specified).

The greatest degree of protection is afforded to the seller when the LC has been issued by the buyer's bank and confirmed by the seller's bank. LCs may be utilized for one-time transactions, or they can cover multi-shipments, depending upon what is agreed between the parties. Also, make sure you can deliver within the terms of the LC. It is suggested that you review the details of such documentation with a bank that has LC experience.

LETTER OF CREDIT

                        BUYER      SELLER
     .  Agrees to buy product      .  Agrees to ship goods if LC
                                      is opened
 .  Requests bank to issue LC      .  LC assures payment
                                      if proper documents are presented

                                   .  Ships goods and submits
                                      shipping documents to bank
                                      for payment
    .  Verifies documents for
       compliance

      .  Payment is made when      .  Payment received
documents received or accepted        immediately or upon
                                      maturity of accepted draft

Documentary Collection (Drafts)

Documentary collections involve the use of a draft, drawn by the seller on the buyer, requiring the buyer to pay the face amount either on sight (sight draft) or on a specified date in the future (time draft). The draft is an unconditional order to make such payment in accordance with its terms, which specify the documents needed before title to the goods will be passed.

Because title to the goods does not pass until the draft is paid or accepted, both the buyer and seller are protected. However, if the buyer defaults on payment of the draft, the seller may have to pursue collection through the courts (or possibly, by arbitration, if such had been agreed upon between the parties). The use of drafts involves a certain level of risk; but they are less expensive for the purchaser than letters of credit.

DOCUMENTARY COLLECTIONS

                        BUYER      SELLER

    .  Agrees to buy products      .  Agrees to be paid via
                                      documentary collection

                                   .  Ships goods and submits
                                      shipping documents to bank
                                      for collection or
                                      acceptance

.  Documents released to buyer     .  Seller receives payment at
   against payment or acceptance      sight or upon acceptance

Consignment

When goods are sold subject to consignment, no money is received by the exporter until after the goods have been sold by the purchaser. Title to the goods remains with the exporter until such time as all the purchase conditions are satisfied. As a practical matter, consignment is very risky. There is generally no way to predict how long it might take to sell the goods; moreover, if they are never sold, the exporter would have to pay the costs of recovering them from the foreign consignee.

Open account

An open account transaction means that the goods are manufactured and delivered before payment is required (for example, payment could be due 14, 30, or 60 days following shipment or delivery). In the United States, sales are likely to be made on an open-account basis if the manufacturer has been dealing with the buyer over a long period of time and has established a secure working relationship. In international business transactions, this method of payment cannot be used safely unless the buyer is credit worthy and the country of destination is politically and economically stable. However, in certain instances it might be possible to discount open accounts receivable with a factoring company or other financial institution, referred to above.

The following diagram assesses the relative strengths and weaknesses of each method of payment:

METHOD     USUAL TIME     GOODS AVAILABLE     RISK TO     RISK TO
                            OF PAYMENT        TO BUYER    EXPORTER
                                                          IMPORTER

Cash in    Before         After payment       None        Dependent
Advance    shipment                                       upon exporter
                                                          shipping goods

Letter     After ship-    After payment      Very little
of         ment, when                        or none      Relies on
Credit     documents                         depending    exporter to
           complying                         on LC        ship goods
           with LC are                       terms
           presented

Document-  On presenta-   After payment      If draft un- Relies on
ary Col-   tion of draft                     paid, must   exporter to
lection    to buyer                          dispose of   ship goods
Sight                                        goods
Draft

Document-  On maturity    Before payment     Relies on    Almost none
ary Col-   of draft                          buyer to pay
lection                                      draft; no
Time Draft                                   control of goods

Consign-   After sale     Before payment     High         Low
ment

Open       After ship-    Before payment     Relies on    None
Account    ment, as                          buyer to pay
           agreed                            his account

PRIVATE SECTOR EXPORT FINANCING RESOURCES

Commercial Banks

International trade transactions traditionally have been financed by commercial banks. Commercial banks can make loans for pre-export activities. They can also help process letters of credit, drafts and other methods of payment discussed in this chapter. Banks have also become increasingly involved in making export loans backed by United States government export loan guarantees.

Many larger banks have international departments which can help with your company's particular export finance needs. If your bank does not have an international department, it probably has a correspondent relationship with a larger bank that can assist you.

Private Trade Finance Companies

Private trade finance companies are becoming increasingly more commonplace. They utilize a variety of financing techniques in return for fees, commissions, participation in the transactions or combinations thereof. International trade associations, such as a District Export Council, can assist you in locating a private trade finance company in your area.

Export Trading and Management Companies

Both EMCs and ETCs provide varying ranges of export services, including international market research and overseas marketing, insurance, legal assistance, product design, transportation, foreign order processing, warehousing, overseas distribution, foreign exchange and even taking title to a supplier's goods. All of these services can leverage the limited resources of small businesses.

Factoring Houses

Factoring houses, also called factors, purchase export receivables on a discounted basis. Using factors can enable the exporter to receive immediate payment for goods while at the same time alleviating the hassles associated with overseas collections.

Factors purchase export receivables for a percentage fee at 2-7 percent below invoice value, depending on the market and type of buyer. The percentage rate will depend on whether the factor purchases the receivables on a recourse or non-recourse basis. In the case of a non-recourse purchase, the exporter is not bound to repay the factoring house if the foreign buyer defaults or other collection problems arise. Therefore, the percentage charge will be greater with non-recourse purchases.

Forfaiting Houses

Similar to factoring, exporters relinquish their rights to future payment in return for immediate cash. Where a debt obligation exists between the parties, it is sold to a third party on a non-recourse basis, but is guaranteed by an intermediary bank.

One U.S. exporter which used forfaiting found the benefits substantial:

Ed Lamb, President of Custom Die and Insert of Lafayette, Louisiana, was able to sell a 180-day letter of credit through a forfaiting house and got paid 178 days sooner. Forfaiting enabled Custom Die and Insert to consummate a $2.3 million-dollar export order to the Middle East.

GOVERNMENT EXPORT FINANCING RESOURCES

Because private sector financing providers will only assume limited risk regarding foreign transactions, the U.S. government has become increasingly involved in providing export financing assistance. U.S. government export financing assistance comes in the form of guarantees made to U.S. commercial banks which in turn make the loans to exporters. Federal agencies, as well as certain state governments, have their own particular programs as noted below:

U.S. Small Business Administration (SBA)

SBA provides financial and business development assistance to help small businesses develop export markets. The SBA assists businesses in obtaining the capital needed to explore, establish or expand international markets. SBA's export loans are available under SBA's guarantee program. As a prospective applicant, you should request that your lender seek SBA participation, if the lender is unable or unwilling to make a direct loan.

The financing staff of each SBA district and branch office administers the financial assistance programs. You can contact the finance division of your nearest SBA office for a list of participating lenders. The business development staff of each SBA district and branch office can provide counseling on how to request export financial assistance from a lender.

Borrowers can use different SBA loan programs and types of loan guarantees simultaneously, as long as the total SBA-guaranteed portion does not exceed the agency's $750,000 statutory loan guarantee limit to any one borrower. The lender may charge a maximum interest rate of 2.75 percentage points above the New York prime interest rate, or 2.25 percentage points above New York prime if the maturity is less than seven years.

Regular Business Loan Program

The SBA can guarantee up to 90 percent of a bank loan up to $155,000. For larger loans, the maximum guaranty is 85 percent up to $750,000.

Small businesses that need money for fixed assets and for working capital may be eligible for the SBA's regular 7(a) business loan guarantee program. Loan guarantees for fixed-asset acquisition have a maximum maturity of 25 years. Guarantees for general purpose working capital loans have a maximum maturity of seven years. Export trading companies (ETCs) and export management companies (EMCs) also may qualify for the SBA's business loan guarantee program.

To be eligible, the applicant's business generally must be operated for profit and fall within size standards set by SBA. Loans cannot be made to businesses involved in creation or distribution of ideas or opinions, such as newspapers, magazines and academic schools. Other types of ineligible borrowers include businesses engaged in speculation or investment in rental real estate.

Export Revolving Line of Credit Program

The Export Revolving Line of Credit (ERLC) Program offers a credit line up to 36 months. Any number of withdrawals and repayments can be made as long as they do not exceed the dollar limit of the credit line, and the disbursements are made within the stated maturity period. Loan maturities are generally for 12 months, with options to renew.

Loans can be used to finance labor and materials for manufacturing or wholesaling for export, to develop foreign markets or to finance foreign accounts receivable. Foreign business travel and participation in trade shows are also among the eligible uses, but a regular 7(a) business loan may be more appropriate for these purposes.

Applicants must satisfy eligibility criteria established for all SBA loans. Also, the applicant must have been in business -- not necessarily exporting -- for at least 12 months' continuous operation before filing an application. The 12-month requirement may be waived by the SBA regional office, if the firm's management has sufficient export experience or enough management ability to warrant an exception.

The International Trade Loan Program

The International Trade Loan Program provides long-term financing to help small businesses compete more effectively and to expand or develop export markets.

Loan maturities cannot exceed 25 years, excluding the working capital portion of the financing. The SBA's guarantee cannot exceed 85 percent of the loan amount. The agency's maximum share for facilities or equipment loans is $1 million, plus $250,000 for working capital.

Proceeds may be used to purchase or upgrade facilities or equipment, and to make other improvements that will be used within the U.S. to produce goods or services.

No debt payment is allowed. Proceeds can be used to buy land and buildings; build new facilities; renovate, improve or expand existing facilities; and purchase or recondition machinery, equipment and fixtures. The working capital portion of the borrowing could be in the form of either an ERLC or a portion of the term loan.

Applicants must establish either of the following to meet eligibility requirements:

• Loan proceeds will significantly expand existing export markets or develop new ones.
• The applicant's business is adversely affected by import competition.

Small Business Investment Company (SBIC) Financing

A Small Business Investment Company (SBIC), approved and licensed by the SBA, may also provide equity or working capital exceeding the agency's $750,000 statutory maximum. SBICs can invest in export trading companies in which banks have equity participation as long as other SBIC requirements are met.

Export-Import Bank of the United States (Eximbank)

Eximbank is an independent federal government agency responsible for assisting the export financing of U.S. goods and services through a variety of information service and insurance, loan and guarantee programs. Eximbank has undertaken a major effort to reach more small business exporters with better financing facilities and services, to increase the value of these facilities and services to the exporting community, and to increase the dollar amount of Eximbank's authorizations supporting small business exports.

Eximbank's export financing hotline provides information on the availability and use of export credit insurance, guarantees, direct and intermediary loans extended to finance the sale of U.S. goods and service abroad.

Briefing programs are offered by Eximbank to the small business community. The program includes regular seminars, group briefings and individual discussions held both within the Bank and around the country.

Export credit insurance programs reduce an exporter's risk and can be obtained through an insurance broker or from Eximbank's Insurance Division.

A wide range of policies is available to accommodate many different export credit insurance needs. Insurance coverage:

• protects the exporter against the failure of foreign buyers to pay their credit obligations for commercial or political reasons;
• encourages exporters to offer foreign buyers competitive terms of payment;
• supports an exporter's prudent penetration of higher risk foreign markets; and
• gives exporters and their banks greater financial flexibility in handling overseas accounts receivable.

During the first two years, the new-to-export insurance policy offers a short-term (up to 180 days) insurance policy geared to meet the particular credit requirements of smaller, less experienced exporters. Under the policy, Eximbank assumes 95 percent of the commercial and 100 percent of the political risk involved in extending credit to the exporter's overseas customers. This policy frees the smaller exporter from "first loss" commercial risk deductible provisions that are usually found in regular insurance policies. The special coverage is available to companies which are just beginning to export, or have an average annual export credit sales volume of less than $2,000,000 for the past two years, and meet the SBA definitions of small business.

The umbrella policy also covers short-term receivables of companies with only limited experience in export trade. These policies are available to commercial lenders, state agencies, finance companies, export trading and management companies, insurance brokers and similar agencies to insure their clients' receivables. Exporters are eligible if they have average annual export credit sales of less than $2,000,000 for the past two years and meet the SBA definitions of small business.

Loan Programs

The Working Capital Loan Guarantee Program assists small businesses in obtaining crucial working capital to fund their export activities. The program guarantees 100 percent of the principal and interest on working capital loans extended by commercial lenders to eligible U.S. exporters. The loan may be used for pre-export activities such as the purchase of inventory, raw materials, the manufacture of a product or for marketing. Eximbank requires the working capital loan to be secured with inventory of exportable goods, accounts receivable or by other appropriate collateral.

Direct and Intermediary Loans

Eximbank provide two types of loans, direct loans to foreign buyers of U.S. exports and intermediary loans to fund responsible parties that extend loans to foreign buyers of U.S. capital and quasi-capital goods and related services. Both the loan and guarantee programs cover up to 85 percent of the U.S. export value, with repayment terms of one year or more.

Direct loans of any size and long-term loans to intermediaries are offered at the lowest interest rate permitted under the Organization for Economic Cooperation and Development (OECD) arrangement for the market and term.

Medium-term intermediary loans are structured as "standby" loan commitments. Under this arrangement, the intermediary may borrow against the remaining undisbursed loan at any time during the term of the underlying debt obligation. There is a prepayment fee if it is triggered by prepayment of the foreign borrower.

Guarantee Programs

Guarantees of the Eximbank provide repayment protection for private sector loans to credit worthy buyers of U.S. capital equipment and related services. The guarantee is available alone or may be combined with an intermediary loan.

Most guarantees provide comprehensive coverage of both political and commercial risks but political risks only coverage is also available. The guarantee covers 100 percent of principal and interest. In the event of a default, the guaranteed lender must file a claim no less than 30 and no more than 150 days after the default. The claim will be paid within five business days after receipt.

Customary repayment terms for capital goods in international trade are:

     Contract Value           Maximum Term
     Less than $75,000        2 years
     $75,000 - $150,000       3 years
     $150,000 - $300,000      4 years
     $300,000 or more         5-10 years, depending on the nature of the
sale and the OECD classification of the buyers' country.

Loans for projects and large product acquisitions, such as aircraft and capital-intensive machinery, are eligible for longer terms while lower unit value items such as automobiles and appliances receive shorter terms.

Commodity Credit Corporation (CCC)

The United States Department of Agriculture's Commodity Credit Corporation (CCC) operates Export Credit Guarantee Programs to provide United States agricultural exporters or financial institutions a guarantee that they will be repaid for short- and intermediate-term commercial export financing to foreign buyers. These programs protect against commercial or noncommercial risk if the importer's bank fails to make payment. Under one program, the CCC will guarantee credit terms of up to 3 years and under another, credit terms from 3 to 10 years are guaranteed. (For more details, see Part II, The Exporter's Directory.)

State Export Financing Programs

A number of state-sponsored export financing and loan guarantee programs are available. Many cities and states have established cooperative programs with the Eximbank and can provide specialized export finance counseling. Details of these programs are available through each state department of commerce or trade office.

Arkansas, California, Delaware, Georgia, Indiana, Louisiana, Maine, Maryland, Massachusetts, Michigan, Minnesota, New Jersey, New York, Nevada, North Carolina, Oklahoma, Pennsylvania, South Carolina, Texas, Utah, Virginia, Washington, and Wisconsin all provide direct or indirect export financing assistance.

Once an exporter determines the kind of export financing assistance to be used and which payment method, the next step is to arrange for delivery of the goods to the buyer's destination. It is important to assess the various transportation options available, the subject of Chapter 7, "Transporting Goods Internationally."

Next: Chapter 7 - Transporting Goods Internationally