PPE-andora’s Box: The Challenges of Financing Personal Protective Equipment Suppliers

In the months following the onset of the COVID-19 pandemic, stockpiling personal protective equipment (PPE) has become a necessity. To address this need, many companies have started to supply these resources. This trend has created many opportunities for factors to provide working capital, but those opportunities come with many challenges. Bryan Ballowe of TradeCap Partners and Michael Ullman of Ullman & Ullman dive into the niche factoring arena for PPE suppliers.

BY BRYAN BALLOWE AND MICHAEL ULLMAN

For those of us who consider ourselves seasoned veterans in the commercial finance industry, we like to think “we’ve seen it all” or “nothing can surprise us.” Many of us feel confident that we have taken all the necessary precautions to deal with unwanted surprises in our portfolio and that our underwriting and monitoring procedures are air-tight. Just as quickly as we get comfortable, we also sometimes become complacent and, inevitably, something that we fail to foresee or imagine happens.

From terrorist attacks to recessions, most of us have endured a lot during our careers. However, it’s safe to say that 2020 is a year none of us will forget on many levels.

Up until recently with the November election, the single largest story that has dominated our daily lives has undoubtedly been the effects of the COVID-19 pandemic. In late February, we all were wondering what just hit us and how long it would stick around. At the time, we wondered about the pandemic’s severity and what, if anything, we had to do medically, socially and certainly professionally.

PPE INDUSTRY BOOMS

One of the many effects caused by this global crisis has been the incredible need and demand for items mandated by Federal Occupational Safety and Health Administration requirements, which we mostly took for granted. Some of these commodities are commonly referred to as personal protection equipment, or PPE, and include masks, ventilators, thermometers, gowns, face shields, syringes and gloves, just to name a few. With the tidal wave of increased demand came a significant opportunity for suppliers — as well as their lenders and other sources of capital — to step up in order to source and deliver PPE to those who were in desperate need outside the occupational setting. Little did anyone know that when demand for PPE exploded, a Pandora’s Box of significant risk opened to not only suppliers of PPE but also their lenders and financial partners.

Right when the pandemic started, the demand for PPE was so significant that many companies pivoted on a dime to help or, perhaps, take advantage of significant sales opportunities. The demand for PPE came from everywhere, including governmental agencies, retailers, private companies and more. Everyone needed product and was willing to contract with anyone who could deliver — or promised to deliver. Many suppliers had good intentions to meet demand; however, many of those companies had little to no experience selling PPE or the knowledge of the regulations and requirements associated with selling such items. While some companies had significant experience and were poised to meet the significant demand, others were simply looking to take advantage of the situation to make a quick fortune or defraud others in order to do so. Desperate customers were paying cash upfront for product that never existed, had been allocated and sold elsewhere, was not of the quality ordered, or was eventually confiscated by overseas governments. Simultaneously, many lenders were exposed to a completely new landscape of risk that they had never faced before.

REGULATORY ROADBLOCKS

In addition to the bad actors surfacing in the marketplace, many lenders and their clients found themselves facing strict regulatory requirements for PPE. To say that the regulatory requirements for PPE are complicated and extremely cumbersome is an understatement. This created a significant learning curve for both suppliers and lenders alike to overcome, leaving many questions to try to answer in a very short time. Which goods are regulated? What is the governing body that sets the rules? What classification does the product fall under? What certifications and licenses are required? Are clients sourcing from factories that are approved by agencies such as the FDA and Health Canada? If so, are the factories adhering to regular audit programs? Do overseas suppliers have approval to export goods from the country of origin? If a lender’s client is sourcing from a third-party intermediary, how do the parties involved verify if an approved manufacturer is producing the goods? Are the goods properly labeled and do they adhere to governmental requirements? Do clients selling PPE have proper 510(k) certifications and/or MDL or MDEL licenses to market the PPE they are selling in the first place? The regulatory requirements lenders found themselves dealing with created more of a legal nightmare and risk profile than most were willing to manage.

SUPPLY CHAIN CHALLENGES

Whenever global demand outweighs supply to the extent it has in the PPE space this year, the inherent risks associated with sourcing and supply chain management become significantly magnified. One of the biggest issues facing companies selling PPE and their lenders is that overseas suppliers require large cash deposits or even 100% payment upfront prior to goods being produced and shipped. While deposits are nothing new when it comes to sourcing goods from overseas, sending large deposits or even pre-paying for goods that are in such demand under these challenging times poses a significant risk.

Many overseas suppliers that require large cash deposits or prepayment in full are intermediaries and have very limited ability to deliver the amount of product they are promising to deliver. Some suppliers that do have product regularly sell goods otherwise allotted for those who already prepaid to the next highest bidder that comes along. In addition, some overseas factories that require large cash deposits and prepayments have been unable to keep up with demand and have had to push back delivery dates well into the future.

Securing product is only half the battle. Freight rates and container availability has been a significant issue for many importers during this time. Since goods in the PPE space are highly regulated, customs agencies have increased the number of containers they are examining to verify the authenticity and quality of the PPE being imported. Additionally, customs agencies have turned away or even seized many containers if required certifications and necessary paperwork is not in order.

DUE DILIGENCE

Lenders also should be aware of the credit profile of their clients’ customers as well as the risks associated with the repayment of PPE. Many suppliers are selling to distributors who do not have the ability to pay for goods unless those distributors receive payment first. Meanwhile, many end customers are setting up escrow arrangements to provide security of payment for goods. While these arrangements are commonplace in industries such as real estate, many escrow arrangements for PPE do nothing more than create additional layers of paperwork and costs when the focus should be on dealing with a creditworthy end customer in the first place.

Additionally, lenders must be aware of required inspections of end-user customers and become comfortable with the requirements as well as the location and timing/duration of these inspections. Inspections are understandable, but many end-user buyers (especially distributors in this space) hide behind an inspection to haggle on price, delay payment or even walk away from the transaction. Prices and demand for PPE can be very elastic and can change overnight. At the beginning of the pandemic, the demand for all types of PPE was so high that customers were ordering goods from multiple suppliers to reduce the risk of nondelivery. As the supply of certain items has normalized, many end buyers are pushing out deliveries, reducing the price they are willing to pay or even cancelling orders altogether.

Lastly, most of the new companies supplying PPE have limited to no experience whatsoever in this space. As mentioned earlier, many companies changed their entire business model simply to take advantage of the opportunity created by the significant demand for PPE. Although many of these companies have experience sourcing other goods from overseas suppliers, the unique risks and highly regulated nature of these goods, as well as the extremely volatile supply chain, makes selling this type of product extremely challenging even for those companies that have focused on selling PPE for years.

BEST PRACTICES FOR CAPITAL PROVIDERS

For lenders and factors, there are measures and best practices to mitigate many of the risks associated with financing companies that now supply PPE. In each of the authors’ humble opinions, the experience of the borrower/factoring client is quintessential. Vetting a borrower’s/ factoring client’s history of successfully sourcing and delivering goods, as well as being paid, helps answer many of the questions and mitigates many of the risks associated with these types of goods. Additionally, having a thorough understanding of the regulatory requirements associated with supplying PPE and knowing which resources to access to verify requirements are met will go a long way in successfully lending in this space.

Finally, sticking to structure is key. Bank instruments such as letters of credit can significantly reduce the risks associated with sourcing PPE from overseas suppliers. While many overseas suppliers still require cash deposits, mitigating the risks associated with cash deposits is paramount. Additionally, understanding issues surrounding the issuance of ocean and air freight bills of lading and marine cargo insurance, adhering to a strict policy of monitoring end-user customer credits, verification of customer orders and payment terms, and maintaining the ability to control goods at all times will go a long way in successfully lending to or factoring for companies that supply PPE. •