Working Capital: Three Smart Tips for Borrowing from Customers
When Van Strom, president of American Design & Manufacturing, a $2-million advertising-specialty manufacturer in Seattle, decided to buy a $100,000 embroidery machine last winter, he financed it through an unorthodox source: one of his company's biggest customers. "I could see that we would both benefit," he says. "Increasing our production capacity would increase our ability to service that company's account, so it made sense for it to help us make the purchase."
The customer would advance $30,000 as the down payment for the new machine, with Strom's company paying the rest of the cost in monthly installments. American Design would then pay off the $30,000 credit, plus an interest charge (calculated each month at current rates), by fulfilling production orders from its customer, rather than by paying cash.
"The deal was so simple, so clean, so fast," Strom says. "I just drew up a letter stating the terms of the arrangement and promising that if our company ever became unable to fulfill the orders, American Design or I would pay off the credit with cash instead."
Strom offers three tips for borrowing from a customer: approach cash-rich customers, since companies can afford to act only if their cash flow supports it; emphasize mutual benefits because customers otherwise will have little incentive to become your banker; and control payback terms.
The third lesson, Strom concedes, he learned the hard way: "We failed to anticipate how much demand that company would have for our product. Its orders came in so quickly -- without cash payments attached, of course -- that we had to stretch our other payables to meet payroll." The next time he borrows from a customer, the CEO plans to specify six months as a minimum payback period so that American Design has time to work on cash-producing business, too.* * *