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Purchase Order Financing for Startups
Everything You Need to Know
Key Takeaways
- PO financing is an alternative financing solution that allows borrowers to build up their inventory to fulfill customer orders.
- Borrowers don’t need to put up collateral in order to qualify for PO financing. The customer’s invoices already serve as collateral.
- In case all customer invoices have not been paid yet and you need the money ASAP, you can sell your invoices. This process is called invoice factoring
- You don’t need good credit to qualify for purchase order financing. Startups like you only need to have credit-worthy customers and reputable manufacturers or suppliers.
Need immediate funds for the mass production of goods? Most small businesses and startups get purchase order financing because it gives them additional capital to fulfill their customers’ orders. With PO financing, companies are able to capitalize on their active purchase orders to make sure their products are delivered to customers on time.
If you’re a startup company and you’re not sure how PO financing works, this article will help you. We’ll cover everything you need to know – from the processes involved in a successful purchase order financing to the application requirements.
We also prepared a list of questions you need to ask before moving forward with any purchase order financing company. And if at the end of this guide you’ll find that PO funding is not what you need, we have here other alternative financing solutions that might work for your startup.
What is Purchase Order Financing?
Purchase order financing is a type of small business financing that lets you fulfill your customers’ orders even when money is tight. In cases where demand for your goods is high and you don’t have the money to produce them, you can seek for purchase order financing to deliver your promise to consumers.
Purchase order financing is beneficial to many startups because it covers the cost of manufacturing goods that have been pre-sold to customers. When you send invoices to your customers, they pay directly to the PO financing company you’re working with.
Even if you think that you don’t have a favorable credit rating to qualify for a small business loan, getting PO financing is still a great option. Why? It’s because PO financing companies will look at your customers’ creditworthiness and not yours.
How Does Purchase Order Financing Work?
When you need to replenish your inventory but you don’t have enough capital to make it happen, purchase order financing is the best solution for you. PO financing allows you to fund any production costs, so you won’t have to worry about losing loyal customers in the long run.
Here’s how it works: you will need to find a lender that offers purchase order financing for startups. This lender will cover all manufacturing-related expenses to fulfill your required inventory. In most cases, these companies will be responsible for delivering the goods to your customers. In return, your customers will be paying the financing company.
Any excess payments from the amount you borrowed will be paid back to you, minus service fees and other charges.
While some small business lending options involve direct interaction between a lender and borrower, purchase order financing involves more participants. In fact, this PO process involves four parties to complete the transaction.
Four Parties Involved in a Purchase Order Financing
- Participant 1: the seller who received the customer’s purchase order, who is also the one seeking for financial assistance to complete this order.
- Participant 2: the customer who placed the order.
- Participant 3: the supplier or manufacturer of the goods being requested by the customer.
- Participant 4: the lender or purchase order financing company who will be providing the working capital to pay the supplier.
In every purchasing order financing, startups need to remember that only completed goods are qualified. This means that if you are in the business of selling services or raw materials, you may find it difficult to apply.
Nevertheless, PO financing is still a great way to balance and maintain your operating cash flow. You can use it to fulfill your customer’s orders to make sure they won’t turn away and buy what they need from your competitors.
Do Startups Need Purchase Order Financing?
Definitely. Purchase order financing is designed for startups and other new small businesses who have a hard time building up their inventory due to limited budget. It’s particularly attractive to many entrepreneurs who cannot afford to lose customers; they need immediate funding to manufacture and deliver their products.
In PO financing, the borrower doesn’t need to have a personal guarantee in order to qualify. Most PO financing companies won’t inspect your credit history either. These reasons make PO financing a suitable solution for startups who don’t have a proven track record but are in rapid growth mode.
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How Do You Process Purchase Order Financing for Startups?
The PO financing process involves eight key steps–from receiving your customer’s PO to the production and delivery of goods to the customer’s payment to your lender. Below is the complete step-by-step process.
Purchase Order Financing for Startups: The Complete Process
- Step 1: Receive the Purchase Order from Your Customers
- Step 2: Supplier Will Provide a Cost Breakdown of the Orders
- Step 3: Submit Purchase Order to Your Preferred Purchase Order Financing Company
- Step 4: Your Lender Pays Your Supplier to Fulfill Orders
- Step 5: Your Supplier Will Deliver the Goods to Your Customers
- Step 6: You Send the Invoices to Your Customers
- Step 7: The Customer Pays the Lender
- Step 8: Lender Will Send Back Any Remaining Balances, Minus the Fees
Step 1: Receive the Purchase Order from Your Customers
A purchase order (PO) is a legal written confirmation that a customer places an order to buy your product or avail your service. It is an official document that states who the buyer is, the exact orders they expect to get at any time, and when they should arrive. Once you receive these POs from your customers, you can determine if your inventory is enough to satisfy their request.
Step 2: Supplier Will Provide a Cost Breakdown of the Orders
Once you have your POs, you will coordinate with your supplier to see how much you’ll be needing to meet the demand. Your supplier will provide you with a cost breakdown of the orders, which should show the detailed expenses associated with each PO.
Step 3: Submit Purchase Order to Your Preferred Purchase Order Financing Company
Reach out to your preferred lender to evaluate the details of your purchase order and your eligibility. Take note that each purchase order financing company has their own application process but be prepared with the basic documents. We’ll cover this later.
Step 4: Your Lender Pays Your Supplier to Fulfill Orders
Once you’ve qualified and you were able to submit all the documents your lender needs, the lender will contact your supplier directly to discuss payments..
Step 5: Your Supplier Will Deliver the Goods to Your Customers
Upon receipt of the payment, your supplier may start manufacturing your goods and build inventory. Shipping will typically depend on your arrangement with suppliers–either they will deliver the products to your customers or you will handle that yourself.
Step 6: You Send the Invoice to Your Customers
Your manufacturer will inform you once all products are delivered to your customers. By this time, you should prepare the customers’ invoices and send it to them as soon as possible. Note that the customers will be paying your lender directly, so you’ll have to wait for updates from your lender in case the customer fails to pay on time.
In case your customers won’t be able to pay their invoices on the agreed date, your lender won’t be able to repay you the remaining balances. All transactions must be completed first before they send the excess payments to your accounts.
Step 7: The Customer Pays the Lender
Once the products are received and all invoices have been dispersed, the customer will pay their invoice directly to your lender. The purchase order financing company will collect all payments from your customer until all invoices are paid.
What happens if you need the money ASAP and your customers haven’t paid their invoices yet?
You might want to check invoice factoring. Invoice factoring allows you to sell your customers’ pending invoices to a factoring company at a discounted rate. Majority of factoring companies will give you between 60% to 80% of your invoice’s total value.
You might think that invoice factoring isn’t a good solution considering that you won’t be getting the full amount of your invoices. But in case you really need more cash for urgent situations, this will come in very handy. Factoring companies will oversee credit control, process invoice payments, and collect customer payments so you won’t have to worry about them.
Step 8: Lender Will Send Back Any Excess Payments, Minus the Fees
The lender will send back to you any excess payments minus fees for rendering the services. Typically, the rate associated with your PO agreement will be set by the lender and applied to the cost of filling the order.
Application for Purchase Order Financing for Startups: Basic Requirements and Documentations
- Your customer’s purchase orders
- Supplier’s invoice to you
- Financial statements such as profit and loss statements, balance sheets, and cash flow statements
- Tax filings
- A fully filled out application form
- Any proof showing your engagement with your suppliers and customers
- Business address and contact information
Application for Purchase Order Financing for Startups: Minimum Qualifications
- A finished, completed, or fully assembled product
- A large amount of purchase orders from customers
- Your customers must be other businesses or government entities
- Minimum of 6 months sales history for each customer with the same product
- You must be selling to creditworthy customers
- The total value of your PO must be at least $20,000
- You must have reputable suppliers
- At least 1 year of dealing with suppliers
- Your profit margin should be at least 30%, but this will depend on the lender you’ll be working with.
- Customers who have submitted a PO to you should have good credit rating
Do Startups Need to Put Up Collateral to Get Purchase Order Financing for Startups?
You don’t necessarily need to put up your assets as collateral to secure purchase order financing. Your customers’ outstanding invoices already serve as your collateral. That means, instead of using physical assets such as real estate, inventory, equipment or vehicles, you can capitalize on your invoices.
If your customers fail to pay, you and your lender will have to make one final request for the payment to be made within a certain period. If no action is done, let them know that you will be taking them to Court and file a claim against them.
Apply for Purchase Order Financing Now
PO funding is a great way to maintain business operations as efficiently and as productively as possible. Even startup owners who don’t have good credit rating may still qualify for PO financing. As long as you meet the minimum qualification above, you’re sure to reap the rewards later on.