Tim Anderson Authored an Article for the ABL Advisor Focusing On What To Know About Lending To E-commerce Retailers
Lending to a retail-focused e-commerce platform -- whether it’s a stand-alone enterprise or a component of a traditional brick-and-mortar retail organization -- can be a far greater challenge than lending to a pure play brick-and-mortar retailer. Unique methods are required to accurately establish the liquidation value of an e-commerce platform’s inventory in order to determine a reasonable borrowing base. Similarly, the lender must adhere to an ongoing process for monitoring company operations, the objective being to mitigate its risk in the event of a business failure and eventual liquidation.
As retail e-commerce continues to grow, a greater portion of a lender’s collateral will comprise an e-commerce channel and that channel will become more vital in connection with a liquidation sale. Consider these marketplace statistics:
- Currently, between 8.0% and 9.0% of all retail purchases are made online. In 2014, web sales surpassed $300 billion according to the U.S. Department of Commerce.
- Online retail sales are expected to grow to 11% of all retail sales by 2018 according to a study released in 2014 by Forrester Research, Inc. That’s a 57% increase and an annual compounded growth rate of 9.5%.
- Interestingly, consumers still love their brick-and-mortar stores by an overwhelming percentage. In fact, as online purchasing grows, consumers tend to choose their favorite retailers’ online platforms versus pure-play e-tailers. About 55% of consumers who purchase online prefer to buy from a retailer with a brick-and-mortar presence.
It’s no wonder there’s a growing interest among lenders in the online sector of retailing. So, what are the challenges of lending to an online retailer or online unit of a brick-and-mortar retailer? How should their inventory be properly appraised? How should the inventory disposition process be managed in the event of trouble? Here are the factors driving valuation and liquidation.
Understand the Feasibility of Liquidation
First and foremost, the relative ease or difficulty of liquidating through an e-commerce platform must be established. This requires a review of several factors:
- If the platform is a stand-alone business, is it a viable liquidation channel?
- If the online platform is part of a failed brick-and-mortar retail organization, what is the percentage of sales conducted via the Internet? A reasonable assumption is that a number greater than 10% is significant, which suggests the e-commerce channel is meaningful to the company. Therefore, it could be used as part of the inventory disposition strategy.
- In either case, if the e-commerce platform must be shut down and the inventory liquidated, the attributes of the inventory itself play a key role in determining if it can be liquidated through the e-commerce platform as well as the ultimate recoverable value. As examples, what are the return percentages, warranties, sizes and installation needs of the inventory? What are the costs associated with shipping?
- As a rule of thumb, the easier it is to sell the inventory in normal-course operations, the easier it will be to sell it in a liquidation. For example, branded watches sell well online because they are easily researched and cross-referenced for price, there are no sizing issues and there are no other variables that could cause consumer hesitation. Ergo, branded watches will usually sell well in an online inventory liquidation.
In recent retail e-commerce liquidation sales conducted by Hilco, results suggest ecommerce inventory recovers more similarly to brick-and-mortar retail than to wholesale. Liquidation expenses are typically less than those for brick-and-mortar, which will usually improve the net recovery.
Experience also shows that consumers react to a retail e-commerce liquidation sale in the same manner as they approach a liquidation sale at a brick-and-mortar store. This usually results in strong multipliers.
However, in order to optimize liquidation sale results, it is almost always necessary to transform the existing look and feel of the website to convey “urgency” to the consumer. Initial and follow-on pricing must be developed. Pricing strategies may follow the cadence of a traditional GOB sale. Relevant sale messages must also be developed and delivered through a well-orchestrated marketing campaign involving deft use of email, social media, and search engine strategies.
Establish the Appraisal/Liquidation Model
When conducting appraisals of e-commerce platforms, it is typical to use an exit strategy that mirrors a conventional brick-and-mortar liquidation. A model is created wherein the direct-to-consumer online channel is utilized, but not for the entire term typically assigned in a brick-and-mortar sale. The model also anticipates that the liquidator will need additional time on the back end for fulfillment of e-commerce orders in the pipeline. The strength of a company’s customer database is also an important variable in the model in order to optimize the liquidation strategy with respect to marketing, particularly direct marketing.
Key performance indicators, as well as overall sales performance, are the primary metrics used when determining the amount of product to be sold through the online channel. The model must also project liquidation expenses, which typically include online marketing and other costs associated with selling to consumers online under normal operating conditions.
The model assumes customers would be attracted to the sale website via existing advertising programs and pay-per-click schemes currently in use by the company. Content would, of course have to be tailored to the sale event. More focused e-mail blasts and selected advertising as employed by the liquidator would also be built into the model. Finally, the appraisal/liquidation model should include a provision for the disposition of less-desirable inventory remaining unsold as the sale event moves toward completion.
Conduct Due Diligence to Mitigate Risk
A lender must carefully monitor several key areas of the retail e-commerce borrower’s operations to ensure that, in the event of a liquidation sale, risks have been effectively mitigated. It is advised to pay particular attention to the following:
1. Regarding the website(s):
a. Is the entire e-commerce platform being properly maintained?
b. Is the technology being upgraded as it evolves?
c. Would the website be transformable into a viable sale channel in the event a sale is required?
d. Are all designs associated with the company’s products, as currently being sold or as would be sold to generate revenue in the event of a liquidation, free of creditor and vendor liens?
e. Would all products be freely accessible to the liquidator?
2. Regarding intellectual property:
a. Would all intellectual property be unencumbered at the time of a liquidation sale?
b. Would all corresponding domain name registrations be up-to-date and paid through the end of a potential sale period? Should a domain registration lapse, a third party could claim the domain name for itself. Losing ownership of the domain name would likely make it unavailable for use during a sale.
c. Would customer contact information be readily available and usable (see #4, below)?
3. Regarding Website Staffing, Hosting and Servicing:
a. Most e-tailing websites are operated using a hybrid system of internal staffing and outsourced web design and hosting. Rarely is a website managed entirely by an in-house staff. Therefore, the lender must carefully monitor employee staffing as well as web design and server hosting contracts. All agreements must be current, paid to the date leading up to a sale and paid through the end of a sale to ensure servers and content are available for use.
4. Regarding Customer Data:
a. It is important to understand the scope and nature of customer data and where it is stored? Is the server owned by the company or by a third party?
b. The liquidator must be able to communicate with customers, therefore, if customer data is stored with a third party are all agreements current, paid to date leading up to a sale, and paid through the end of the sale, to ensure the data is available for use.
Properly appraised and monitored, a retail e-commerce business should entail little or no additional risk for a lender than a traditional brick-and-mortar retailer. So long as (1) a viable disposition channel exists, (2) the nature and salability of the inventory is understood by the lender, and (3) the operational aspects of the business are carefully monitored, then maximizing the value of the inventory in a liquidation sale should be achievable with a high degree of certainty.
Source: ABL Advisor