Cash, Letter of Credit, Standby Letter of Credit, Collateral, Small Business Administration (SBA), Export Working Capital Program (EWCP), Guarantee
An engineering company in Boulder, Colorado, designs and builds shake-tables used to simulate vibrations and movements. The hydraulics mounted underneath the table are operated by computers which are programmed to simulate movements ranging from minor vibrations to earthquakes. Equipment manufacturers, electric utilities, etc. buy the custom-built tables to test equipment prior to installing it in their power plants and for product qualification.
The company in Boulder received an order for a shake-table from a ship builder in Korea. The buyer wanted the shake-table to simulate the vibrations of a ship and the motion of the waves. In this way he could test the durability of the equipment prior to installation in ships.
The engineering company had to invest a considerable amount of money in engineering, parts, and labor to build the table to the buyer’s specs. In this transaction they negotiated payment terms as follows: 40% cash in advance, 50% payable by a letter of credit upon presentation of shipping documents, and 10% upon acceptance by the buyer after installation of the shake-table and completion of on-site training.
Securing the Cash Payment
The buyer in Korea had one condition for the 40% cash payment. He wanted a standby letter of credit for an amount equal to the down payment, payable to the buyer upon his certification that the exporter failed to build the shake-table. The standby letter of credit would provide assurance that the buyer could get his money back in the event the supplier never produced or shipped the goods. The supplier asked a bank to issue the standby letter of credit.
By way of a brief background, the supplier was a well established, proven, capable and well managed engineering firm. However, the de-regulation of the energy industry caused a collapse of a major market segment for this company. As a result, at the time of the Korean contract, the company’s liquid collateral had weakened. This contract to Korea proved their proactive effort to diversify into other markets.
When the bank received the request for issuing the standby letter of credit, they agreed to only do so with cash collateral. This caused a “catch 22” for the supplier. In order to get the cash payment he needed a standby letter of credit. In order to get the standby letter of credit he needed the cash. The bank partially resolved this problem by stating in the letter of credit that it would become effective upon the bank’s receipt of the cash in advance. However, this did not help the supplier’s cash flow. If the bank kept the cash to secure the standby letter of credit, the exporter would not have use of the cash and would be no better off than before issuing the standby letter of credit. Enter a government program.
Assistance from The Small Business Administration (SBA)
The Small Business Administration (SBA) of the U.S. government has a program to assist with the financing of exports. The program, “Export Working Capital Program” (EWCP), provides guarantees to banks to eliminate a major portion of the risk. In short, if an exporter has an order with an acceptable, firm means of payment and can prove ability to perform, the transaction may qualify for the guarantee.
Since this company had a proven track record of performance with many satisfied customers, SBA issued a guarantee, which enabled the bank to issue the standby letter of credit without the cash collateral. The company then had use of the cash for the purpose intended. SBA’s guarantee also allowed the bank to advance funds over and above the standby letter of credit. This enabled the company to borrow money for purchasing raw material and meeting payroll during the six months it took to build the equipment.
The company constructed the three-axis shake-table on schedule, received payment and paid off the loan, thanks to the SBA.
