Can a Purchase Order Loan Keep Your Business Growing? This little-known financing alternative can be the lifeline you need when banks aren't lending.

George Tarrab's company, Slider the UNscooter, debuted its product line in 2008 and quickly sold 250,000 ride-on scooters. Then came the downturn, and banks weren't interested in extending credit to startups. Private investors were interested, but Tarrab didn't want to give up an ownership stake in the Simi Valley, Calif., company.

But Slider sales were growing faster than the company's cash flow could handle. Tarrab landed major orders from customers such as cataloger Hammacher Schlemmer. To fulfill these orders, Tarrab first needed to find the money to pay for manufacturing the scooters.

The solution: purchase-order financing. In June, based on the good credit rating of customers like Schlemmer, specialty lender PurchaseOrderFinancing.com provided more than $200,000 in funding to get the scooters made. Purchase-order lenders charge substantial fees, but Tarrab says he's still glad he used this strategy.

Thanks in part to its lending arrangement, Slider is now forecasting nearly $3 million in sales next year. The P.O. loan let Slider negotiate better order pricing, freed up cash to spend on marketing, and allowed Tarrab to go after new, high-volume clients.

"It's a little crazy," Tarrab says, "but we had to get creative."

Purchase-order finance isn't new, but lenders say interest in P.O. loans has boomed in the past two years, as bank lending tightened. A typical P.O. borrower is a product manufacturer or wholesaler delivering goods to big customers such as national retailers or a government agency. PurchaseOrderFinancing.com founder Dan Casey says he's seen "explosive growth" at his 9-year-old Chicago firm.

How a Purchase-Order Loan Works
A P.O. loan is a fee-based, short-term loan--there is no interest charged. The transaction works like this: A business receives a large order but doesn't have the cash to get the required goods made. To see if a loan can be made, the P.O. lender investigates the credit history of the borrower's big customer--not the credit history of the small business seeking the loan. If that big end customer has a solid track record of paying its bills and has the cash flow to pay for the goods it has ordered, a loan can be made.

"We don't care about [our] client's credit score or if his business is completely underwater," says Richard Eitelberg, founder and president at purchase-order lender Hartsko Financial Services in New York. "We look only at the transaction we're financing."

If the borrower's big customer has good credit, the P.O. lender delivers a letter of credit to the manufacturer that guarantees payment for the needed goods. The factory then makes the products, and a third party verifies that the order is complete. The factory gets paid and ships the goods off, usually to a third-party warehouse. It's rare for the borrower to receive the goods--they're usually shipped straight to the customer.

When the bill's paid, the funds go to the P.O. lender, which subtracts its fee and sends the remaining profits to the borrower. Without revealing what he charges, Eitelberg says Hartsko doesn't make a loan unless the product has at least a 30 percent margin, so as to leave enough room for the small business to still make a meaningful profit.

If the borrower has given the big customer payment terms of 60 or 90 days, often another type of specialty lender, known as a factor lender, comes into the picture to provide immediate payment to the P.O. lender. The factor lender buys the outstanding invoice at a discount and then waits and collects the full amount owed later, pocketing a profit in the process. Meanwhile, the P.O. lender and the small business get paid immediately. Factoring adds another cost but may be required by the P.O. lender.

Until recently, there were only a handful of active purchase-order lending companies nationwide, but that's starting to change. New companies are springing up, and some lenders who provide factor loans are branching out into P.O. lending. For instance, factor lender Factors Southwest in Phoenix recently expanded to offer P.O. lending to its existing clients after seeing strong customer interest, managing member Robyn Barrett says.

Some P.O. lenders are also getting more flexible on how much risk they are willing to shoulder in a P.O. loan. At 20-year-old Maryland company CTRL Systems, CEO Robert Roche says he found a P.O. lender ( ECAP LLC in White Plains, N.Y.) willing to finance the manufacture of components for the company's ultrasound-diagnostic equipment. CTRL then takes delivery of and assembles the ultrasound machines at its own factory in Maryland.

CTRL turned to P.O. loans after seeing sales and cash flow decline, then begin growing again, leaving the company cash-strapped. The company has done two separate P.O. loans to cover component manufacturing costs, Roche says, each time borrowing less than $100,000.

"This relationship with the P.O. lender gives us the confidence that we can go out and secure significant new business and fulfill those orders," he says.

Factors Southwest's Barrett says she advises clients to consider other finance options--including liquidating assets--before turning to P.O. loans. But if there's nothing else available, a P.O. loan can keep a company growing. Says Barrett, "Use it as a last resort."