Turning collection headaches into profit opportunities.

• Author: Peak, John E.
• Position: Balance Sheet Management - Column

Setting up a joint venture between a manufacturer and a finance company can be a real boon for a company with large volumes of receivables weighing down its balance sheet.

The economic downturn has made it more important than ever for financial executives to protect their organizations against bad credit risks. Those who need to be on special alert include manufacturers selling to dealers of products particularly sensitive to swings in the economy, such as consumer durables, power sports, outdoor power, farm equipment, furniture and musical instruments.

As more dealers fall past due on their payments or even go bankrupt, their suppliers can suffer significant chargeoffs. Fortunately, companies with large amounts of receivables can dramatically improve their balance sheets by partnering with a financial services firm to create a joint venture -- a separate company that oversees and jointly manages the credit and collection processes. The manufacturer becomes a profit partner in the venture, able to use the finance company partner's people, sophisticated systems and capital. The entire arrangement can be transparent to the manufacturer's customers.

The joint venture offers a fresh approach to healthier balance sheets and the ability for manufacturers to grow their business. To enter into a joint venture, the manufacturer contributes equity based on a percentage of the net receivables held by the venture.

For purposes of illustration, let's assume that the manufacturer and the finance company each put in 7.5 percent of the total receivables. The manufacturer has $100 million in receivables. The venture takes the $100 million off the manufacturer's books and, in return, requires an investment in the venture of $7.5 million. It then gives the manufacturer $92.5 million in cash. As the receivables grow, the manufacturer contributes proportionately greater equity. But if receivables decline, the need for equity falls, and the manufacturer gets money back.

Although the equity contribution is virtually equal, the recommended ownership split for the venture is at least 51 percent for the finance company, with the remainder for the supplier. This enables the venture to operate on a balance sheet separate from the manufacturer's, but still gives the manufacturer a 50/50 voice in election of board directors and other decisions in the venture's control.

The joint venture is a low-cost alternative to securitization, another widely publicized method of outsourced financing. In securitization, the manufacturer sells receivables into a securitization conduit. The loans are repackaged and sold as securities, which entitle the owner to some or all of the repayments on the loan. To protect the securitization vehicle from loss, the manufacturer often is required to contribute additional collateral equaling as much as 30 to 40 cents on each dollar of receivables, compared with the estimated 7.5 cents for the venture equity requirement.

Cash Finds Many Good Uses

Virtually any manufacturer partner in a joint venture can find enough good uses for the cash to more than justify its equity...