Thursday, June 3, 2010 - Article by: MBGM Capital Inc -
Contract Funding: A Crucial Building Block for Promising Developers & Sellers
More often than not, whether a start-up, mid-sized or large company, businesses need capital to grow and mature. But
conventional capital acquisition places a company in an undesirable position. This is only exaggerated when its vision is
progressive or unique, or when it has fewer than two years under its belt. Capital is required to develop and expand, which, in
turn, promotes positive cash flow.
Imagine, for instance, a software developer or manufacturer introducing a revolutionary new product to the market. With
concept or prototype in hand, its sales force can realistically acquire advanced development contracts from major corporations
or government entities. What happens, though, when an innovative start-up firm designs a foolproof product or a service and
lands a contract with a rated company or a government entity? This developer or seller will need significant funding to make
their concept a tangible and profitable reality. When a business or private individual needs advance funding, their immediate
thoughts turn to traditional or investment banks.
But traditional funding avenues require upfront fees, annual fees, closing fees and extremely low loan-to-value (LTV).
Furthermore, the company will face a lengthy underwriting process with arduous documentation mandates, ultimately
sacrificing ownership in their project. Traditional methods also require full recourse potential.
With contract funding, the financing company focuses on the entity responsible for paying on the instrument rather than on
the developer or the seller of it. Contract funding can help developers or sellers obtain much-needed advance funding to
support unconditional investment-grade contracts without the complexities associated with traditional or investment bank
financing. Instead, contract funding leverages an existing asset as collateral, including advance development contracts. This
type of funding allows the developer to offer flexible terms to the company or government entity (also known as the offtaker)
that is awarding the contract. It can also provide immediate cash when used against assets such as certificates of deposit
or tax credits with a future maturity or pay-out date. Because it is tied to the collateral instrument offered, contract funding is
The collateral for this type of financing needs to be an assignable instrument with measurable value, such as:
o Mutual Funds
o Unconditional Contracts for Purchase Goods
o Irrevocable Letters of Credit
o Unconditional Retirement Packages
o Tax Credits
Following are some scenarios in which contract funding is applicable:
Normal Corporate Expansion:
A company may want to expand its business, but it cannot bid on larger contracts without increasing staff and buying power
to successfully fulfill the contract. Typically, it would go to a bank or traditional finance company for an operating loan. The
bank may issue financing for an established company, if the company has 20 to 40% down payment. The lender won't look at
this as a corporate transaction, the terms may be only one to five years, and they may lay claim to a controlling percentage of
ownership. Additionally, the cost of funds could be floating, plus upfront fees, closing costs, and annual fees.
Let's say a small software company has a product they believe Dell Computers would like to buy. Normally, the small
company would offer to sell the product to Dell for a low price to get the contract. If they can just get the contract they are
happy, even if it means a very low profit margin. Obviously, though, in this situation, it would be unheard of for them to offer
terms or several years for Dell to pay, because they must have the cash up front in order to make good on the purchase.
Coal Mining Project:
A new coal mining facility needs financing to build. Plenty of buyers have expressed an interest in their product. But unless
they get a commercial loan to finish building, those contracts are useless, and commercial lending isn't fond of natural
resource projects right now. So even if a hard money lender is interested in the project, the pricing will be astronomical and
the hard money lender will take a huge chunk of the project. Without a stellar loan scenario with great credit, huge net worth,
and a low LTV, funding for this project would normally be doomed from the beginning.
Innovative Finance Solution for an Alternative Energy Provider:
A family-owned provider of ethanol was successful but could not bid on larger contracts as they did not have a large enough
staff and facility to manufacture the fuel.
They contacted banks as well as private equity and factoring companies to help them grow. But private equity firms wanted
significant equity stakes in their company and the factoring companies focused on P.O. financing and accounts receivable.
However, the company had an asset that could help--contracts with investment rated companies and government entities.
The main concerns of the finance company were the contracts and the off-taker (the company or entity awarding the contract).
The fuel company braced themselves for a long application process, a lot of paperwork and application fees, and were
pleasantly surprised to learn the finance company only required a brief summary of the relationship between the fuel company
and their off-taker and a copy of the contract.
They expected the process to take at least 90 days and would have to meet a lot of conditions, but the funding could be
completed within 30 days if the contract met only six conditions.
They were concerned about benefits to their off-taker, and learned they could offer terms and other benefits not offered by the
traditional finance company, such as deferred payments and payment start date.
The owners' only regret was that they hadn't discovered contract funding sooner.
Contract funding works for any size company and type of industry as long as the entity awarding the contract is an investment
rated or government entity.
While untraditional in nature, contract funding provides exceptional benefits largely because few in the corporate or financial
world are aware of it. By using contract funding, contracted companies or individuals receive the necessary cash to boost
growth without the affiliated balance sheet liability, helping the company appear even stronger to new investors and other
stakeholders. Yet another perk lies in its highly flexible repayment structure and the lower costs associated with this type of
While commodity-based businesses, which can fluctuate considerably with market changes, are not the ideal client, contract
funding is a reputable solution for developers who receive tax credits for low-income housing, universities, film production
firms, retailers, technology firms, unique businesses such as alternative energy or natural resource companies, large-scale
equipment manufacturers and executive retirement packages. Principals should discuss their situation with a financial planner
or CPA to ensure it offers the best opportunities for their unique situation.
MBGM Capital Inc
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