Letters of Credit
A letter of credit is a document supplied by Paragon Financial that assures payment to a seller of goods primarily used for facilitating trade financing through purchase order financing. The seller is reimbursement from the buyer or from the buyer’s financial institution. The document serves essentially as a guarantee to the seller that it will be paid by the issuer of the letter of credit regardless of whether the buyer ultimately fails to pay. In this way, the risk that the buyer will fail to pay is transferred from the seller to the letter of credit’s issuer. The letter of credit also insures that all the agreed upon standards and quality of goods are met by the supplier.
A common need is for a distributor or wholesaler who needs to import finished goods to fill purchase orders. They usually need a letter of credit issued to their supplier. In this scenario, purchase order funding is a feasible option. The PO financer will require an inspection of goods before the supplier can cash in on the letter of credit.
In a purchase order funding deal, a company known as a factor, will buy or issue a letter of credit for whatever materials a company needs but isn’t able to afford or do not want to pay for with their own money. This often involves the purchase of raw materials needed to manufacture a product to sell to individuals or other businesses. These materials (or products) will be shipped to the business working with the factor. They will then manufacture the product and send it to the customer. The factor is paid after the products have been sold. The best thing about this arrangement is that it can be done without a company having to take on any new debt.
Essentially, the supplier is relying on the credit and guarantee of Paragon Financial for payment of the goods. In a supplier guarantee, the vendor must at least agree to produce the goods initially. Once the goods are produced, we can provide two different guarantees to the vendor:
- Upon receipt of funds from Paragon, the supplier agrees to ship the goods directly to the end user.
- Paragon will guarantee the vendor that once the goods have been shipped, and accepted by the end user, that funds generated from the factoring of the invoice will be wired directly to the supplier. The balance between payment of the purchase order and the gross amount of the invoice will then be wired to you.
In both instances a one page tri-party agreement is put in place between Paragon, you, and the vendor. We have a lot of experience in negotiating with the vendor and most are pleased to have the guarantee in place.
Lets say you are in the t-shirt business. Your company receives a very large t-shirt order from a big-box retailer like Wal-Mart. You need to buy the raw goods from your supplier, but the supplier will not ship the goods. Why would they not ship the goods? Perhaps you are a young startup or it’s the biggest order you have ever placed with them. You simply do not have enough credit to supply all the goods to fulfill the order. They have cold feet and that is when a vendor guarantee comes into play.
A factoring company with excellent credit can leverage against your accounts receivables through invoice factoring. A credit worthy factor with the proper experience can work directly with your supplier to guarantee they get paid. You land a huge order from Wal-Mart and your vendor gets guaranteed cash. It can be the perfect win-win-win scenario all parties involved are looking for.
The factor purchases your accounts receivables from the large order and pays your supplier before paying you. They advanced your t-shirt company up to 85% of your invoice amount. You received the remainder, less the factoring companies fee once the company pays the invoice in full.
The supplier is taking a risk if the order is not completed in a timely manner. The supplier will only consider doing this type of transaction if the relationship between all parties is excellent and they are comfortable payment will be made on time.
When a company has a large opportunity and has good relationships with their supplier, vendor guarantees can get you the critical working capital you need to grow your business.
For over 23 years, Paragon Financial Group has provided working capital solutions for growing companies throughout the U.S. We serve small to large-size companies across a wide variety of industries through accounts receivable, invoice factoring, and purchase order financing up to $3 million per month in volume. Paragon is a leading source for receivables financing, government contract financing, payroll funding, import financing and purchase order financing.