When you need additional funding for your new business, you should really consider purchase order finance over other finance alternatives.
Most of the time, you fund your startup with your own seed money. You probably have what you think is a great idea for a product, and now you want to make those products to sell. To do that, you use all your savings, and maybe even get a mortgage on your home so you can have startup money. Perhaps you even borrow from your friends and close family members who believe in you and your idea.
Potential Financing Problems
The problem with these sources of financing is that they don’t have enough to really fuel your growth. You need lots of working capital, and usually you have to start making your gizmos even before you get your purchasing orders. And getting additional financing can be a problem when you deal with traditional lenders.
In general, banks are hesitant to lend money to startups, because they aren’t all that enamored of the risks involved. Banks see small businesses as too risky, and new small businesses are even more fraught with uncertainty. The failure rate is so high that most banks just don’t bother funding small business startups.
And venture capitalists aren’t any better either. While the news media are full of sensationalized stories about new tech startups getting astronomical sums of money for funding from venture capitalists, the reality is that only a small percentage of new businesses get funding this way.
And there’s another disadvantage, in that with venture capitalists you have to give up a share of your company, which means you give up a share of your future profits.
Using Purchase Order Finance
So let’s say you’ve managed to convince a retailer to buy your products in bulk. They think that your gizmo is terrific, it can appeal to lots of people, and it’s profitable for them. So they place a large order, and that means you’ll need lots of working capital to meet that order.
That working capital will be needed to pay the manufacturing plant you commissioned to do a production run of your product. And they won’t do that unless you pay them upfront. After all, you’re a startup. It’s just too risky for them.
This is the stage where most startups have difficulty moving forward. It’s actually a very common situation, where a startup has a large order and no cash to meet it.
And that’s where purchase order finance comes in. They use the purchase order value as the basis for the cash advance. They take care of the manufacturing cost, and then when you fulfill the order and the customer pays, the lender gets back its advance plus the fee for the financing.
The lender will have some requirements which you need to comply. Usually the lender will have some say as to which manufacturing plant will produce your gizmo. Then you have to demonstrate that you will earn a huge gross margin, at least 30%.
Finally, it’s a good idea to start negotiating for purchase order financing even before you finally get your P.O. The purchase order usually has a deadline (60 to 90 days), so you should have your financing lined up before the order arrives.