Export financing for international expansion
If you plan to expand you company abroad, you will also have to take into account the investments that go along with it. A new market entry may easily costs you 100,000 USD in investments, let alone the working capital. How to determine how much money you need? And what are ways to finance your market entry?
Export financing starts with a good plan and a solid business case
Unless you have unilimited funds and are the only shareholder, you will need to have a good plan in order to get financing. Whether it is for additional investments from your shareholders, for a bank loan, for subsidies or for informal investors, a plan is the basis. And a good plan comes with a business case.
So let's first start with the elements for an international expansion plan, before we get to the sources of finance. Let us cover six elements for this:
- The initial country selection for your exports or expansion plans
- The general process of entering a new market
- Estimating the costs for entering this new market
- Estimating the revenue that you can get from the market
- Checking your data with market research
- Refining your business case so that it is presentable
Then you can start looking for financing:
- For your start-up financing
- For your working capital needs
We will close off with a description of the various rounds of financing you need.
How to select the right country for your exports?
When starting with your export plans, it seems that the whole world is at your feet to be conquered. But where to start?
Which countries not to go?
In general for SME’s we would recommend to exclude a number of countries for your exports:
- Countries with a very low national income per person: the question is whether there is enough buying power to buy your articles.
- Countries with a low number of inhabitants, unless these are very wealthy: perhaps you might be doing a lot of effort for only a small market.
- Countries that rank low on the ‘ease of doing business’ list. Of the around 180 countries that are listed, you shouldn’t go below rank 100, unless it’s a very interesting and promising market for your product.
- Countries with low logistics performance, countries with are boycotted or with unrest or a unpredictable law systems. But mostly these are not the countries with the highest incomes.
How to make a selection from the remaining countries?
You still will find around 60 to 70 countries that might be interesting to do business in. You can rank these for yourself by checking the following aspects:
- Will there be a demand for my products or service? The market for air conditioners in Norway will be smaller than in Italy.
- Is there already a lot of competition? Please also take alternatives for your product into account, e.g. a Thai restaurant might be competition to an Italian restaurant nearby.
- What are my chances of standing out from the competition? Is my product really unique and it is easy to convince others from that uniqueness. Is it relevant in that market? E.g. in a country like Ghana it’s no use having warm lining in the clothing you sell.
What are the characteristics of the market?
There are various aspects that make market entry relatively simple or rather complex, as shown in the figure below.
Distance, language and market size is easy to assess. For estimating the level of bureaucracy there are rankings about ease of doing business, time to import goods or to set up a company. The difference in culture and what impact this may have on your strategy is in general the most difficult to determine. For this you will sometimes need more detailed market research.
Your market entry plan and strategy
You should see you market entry as a business case. Outlay must precede returns. This outlay depends on the product or service you offer but will always be substantial. The trick is how to ensure that there are sufficient returns, and you can get more certainty with market research and partner due diligence are few of the things you can do. This will cost your some money, but reducing your risk factors is enhancing your Return on Investment.
Working with a local agent or distributor is preferred
Of course it is possible to set up an office and hire your own staff in the country where you want to be active. But for most SME's this will be too expensive and too risky. Working with local distributors or partners makes more sense.
Don’t start with the first partner that comes along
One of the most made mistakes is to work with the first partner that comes along. It is better to extend the search first and check the partners thoroughly, which will give you also a better negotiation position where it comes to distribution margins and revenue split. And when the business starts coming in, partner management and quality assurance needs to be in place.
What are the costs to enter a new export market?
Your costs of market entry typically depends on your type of offering. To be able to quickly make an estimate we have defined five broad categories.
- Simple product, perhaps differences per country, but no customisation
- Product with installation, integration or training requirements
- Customised product
- Service that can be provided electronically or from your homeland
- Customised service or solution (e.g. with local consultancy)
Export investments and returns
Each of the categories above has a different profile in terms of investments and returns. If you sell a simple product you may enter a new market with some packaging modifications and by presenting yourself at a few trade shows. In case you offer customised products or services you may have to invest longer before the first small orders come in. This is illustrated in the figure below.
The green line indicates the way revenue will come in: in some cases this may take a while, and then they typically will grow. The red line indicates the costs for entering the market: with a simple product you do not have to spend that much after 2 years, if you have found a good distributor. With a customised service you will need to invest in marketing and the training of your agents and resellers much longer.
A first estimate for total market entry costs
The costs will be based on the activities you need for your market entry. This can involve product adaptions, translations, travel or consultancy and legal fees. In general, the total of costs will depend on your type of offering and the complexity of the market to enter. The table below will give a first indication. It makes a distinction for countries that are simple, average or complex to enter, see our separate post on country selection.
The costs for your market entry is one thing to know. On basis of a business case planning your can determine your cash flow, which already gives more insights. And you should offset your investments against the revenue projection.
How much will you sell in China, France, Brazil or any other country?
An important aspect in your global distribution management is to estimate the revenue that you can expect in the first years when entering a new country.
Methods on market sizing
There are various methods for examining the relevant market size for your product or service in a country. Such an estimate can be based on market size data, buyer interviews and competitor analysis.
- ‘Top-down’ marketing exercise starts from statistics, reports, and other recent studies. From here, your company can plan strategies to penetrate the market. The question is whether detailed data for your specific sector are available.
- ‘Bottom-up’ approach begins from the direct feedback of the buyers and distributors, interviews from other thriving businesses and personal interaction with suppliers. However, some companies may not appear on directories and there is always the issue of individual cultural bias among customers.
- Another technique for market sizing involves adding the sales of other companies that thrive within the market. Building a big picture allows you to see the flow of competition, at the same time improve your marketing strategy. However, not all companies publicly post their financial status, so information may be hard to get.
Compare with your home market
One of the best ways is compare relevant market size of the country where you want to go with the current country or countries you are active in.
- Look at your market share in your home country
- Look at comparable competitors in the target country: what market share do they have
- Estimate the time to build a similar distribution structure or to achieve such a structure through collaboration. Take into account whether your product is really different or better.
- Calculate your growth path for the first few years. Do this in a spreadsheet so you can easily change things.
- Decide what other factors will influence your share: will thing go quicker if you have the right distributor. Or will that distributor also sell competing products?
Expectations may differ with the type of offering
Just before we discussed five types of offerings. Each of these offerings may have a different growth path. A simple product like a lamp or a drill will have a short sales cycle: as soon as you have a distributor and some marketing, revenue will come in. Complex services or complete solutions may have a sales cycle of over a year. If you start in a new market and you don’t have any references there, I may take up to three years before the first revenue comes in.
Market research will take away risks in your planning
Now you know the investment and potential revenues, it is time to think about financing. But any money provider would like to be as convinced as you are. And also you should get some certainty yourself. Nothing is worse for the profitabilty of your market entry than searching a partner, concluding an agreement, adapting your product, training the partner and then to find out that the market is practically non-existent or that your partner doesn't know how to open it.
Start with getting to know the country
This is what happens quite often. And although you can always see it as a learning experience and move on to the next country, these risks can at least be reduced. First of all by knowing the country better than just the airport and the capital's central business district. Or having a trusted person who knows and can help you to define the right entry strategy.
Market research will increase your chances for success
Second of all by researching the market. Extensive (and expensive) quantitative reports mostly do not provide the information that can turn your decision one way or the other. More qualitative research, such as distributor opinions or a pilot with end customers can help to provide that information. This research may lead to a decision not to enter the market: which will save you from a failure.
Typically your market research will answer the following questions:
- What is the local market size and market growth?
- What are trends in the market?
- How is the value chain structured? What are the main distribution channels and market segments?
- What are your competitors and their market position
- What is a competitive price for your products and services on the market?
- What segments of the markets are currently underserved?
- What would be recommendations for entering the market?
The financial value of market research
Even if you decide to proceed with your market entry, research will enhance you likelihood for success. As the calculation example indicates, the weighted statistical outcome will be higher. If you want to know more about this approach, please contact me.
Refining your business case
With the outcomes of the market research you can refine your business case. You know what the market looks like, what your competitors are, what your sales growth path can be. You also know more on the costs for marketing and physical distribution.
Take cash flow into account
With these data you can draft a complete business case, with cash flow projection and return on investment (ROI). Cash flow is especially important because it defines the amount of financing that you need. If your revenues are coming in soon, your working capital requirements can be less.
With an extensive business case you can more easily convince shareholders, investors and banks to finance your international expansion.
Getting back your investments
Most companies start their export efforts with small steps. Although the reason for this may be lack of time, budget constraints or getting more internal commitment first, this actually is spreading your investments over a longer period of time and thus lowering your ROI. Some emerging markets become easier accessible over time, but most markets only become more competitive.
The counterintuitive point of reducing risks in entering new markets is to do it fast. If it's unavoidable to spend a specific amount of money to secure your place in the market, then you'd better do it before the market becomes saturated. Revenue will come in faster, enhancing your profitability.
Distribution management is time-critical, but this doesn't imply reckless behaviour. Proper planning, milestones and go-no-go decisions will be necessary. This is better than 'hiding' your costs, spread over the marketing, travel and business development budget.
Now that you have a market entry plan and a business case, it is time to look at the various options for financing.
Export financing: the start-up phase
Typically during the first stages of your market entry, there will be no revenue yet. You will be busy with market research, planning, orienting, finding and training agents or distributors, and the first marketing actions. Or in case you want to set up your own offices or outlets, with finding locations and hiring staff.
During this period, there is no certainty of success other than your expectation, hopefully backed up by market research. This limits the options for financing.
From your cash flow
If you already have existing operations that generate positive cash flow, this is the best option to use. It will decrease the dividends to the shareholders, who will can this as a further investment.
The risk of waiting for excess cash flow is that it will not come as soon as you expect, and that you will loose market opportunities, since competitors may step in.
In general banks are reluctant to finance a single market entry, unless the company has already proven to be successful in other similar markets. But even then a bank will always search for certainties, which is inherent to the relatively low risk premium they charge as part of their interest.
An internationally working bank will provide you with the option to lend money in the country that you want to target on basis of assets or credit that you have in your home country. But this is merely a small step to get the money on the place where you want to have it, the total credit facility that you will have with that bank will not increase.
Subsidies and government financing
Various government try to stimulate exports and international expansion and have arrangement for this. This could vary from knowledge sharing to subsidies to soft loans or guarantees.
- Subsidies are in general the best option to reduce your costs. They may range from 30 to 70% of various parts of the costs that you make. I know Singapore as one of the most generous nations with 70% reimbursement of your cost for market research and for business matchmaking. Australia goes up to 50%, just as The Netherlands. Also the UK and the US have subsidy arrangement.
- Guarantees are the next-best. With a government guarantee you can take a loan with a bank, but in case you can't pay it back the government will stand in for you. It is important to understand the exact conditions for the guarantee, because in general it is not unlimited.
- Soft-loans are loans, mostly provided by the government, with better conditions than normally a bank would would. In general this results in a lower interest percentage than would be justified by the risk of the venture.
Especially for companies that want to expand to their first or second foreign market, this may be an essential step in the company development. Showing that you can also sell your products or services abroad proves the scalability of your concept, which can add a lot of shareholder value to companies that are based in a smaller country.
You can see your search for financing for your market entry as a second or third investment round. Mostly for these rounds investors are very critical on the information that you provide, so here is certainly the need to come up with extensive market research and a good plan.
One of the elements that we see as being underestimated, is the marketing budget for a new country. Where in your home country you may have been able to grow a crowd of followers on Facebook, this may be much more difficult in a new country. Where should you advertise, with Google adwords or in magazines. Or should you organise events. It all depends on cultural issues and the prominence of each of the communication channels.
Crowdfunding is a way of finding many small investors in stead of one or more large ones. Crowdfunding can be done as pre-ordering, as a loan or as equity. A few thing on each mode:
- If you sell a consumer product and you notice that there already is a lot of demand through the internet for your product from a specific country, you might start a pre-ordering action. Your promise will be: if enough people from the country will pre-order and pay for your product, you will make it available there. Please note that this is actually a sales, and not a financing transaction: you may be obliged to pay VAT on the amount that you received.
- A loan mostly has a term, so you will have to pay it back, preferably with an interest.
- For smaller investments, for a nice product or a product that has a positive impact on environment or human wellbeing, people will invest without asking too much information. For investments from a hundred dollar upwards, your small investors may be as critical as the big ones, so also here you will need to have a very good marketing plan and business case. Which will be (semi-)public, so also your competitors can see it.
Financing your working capital for exports
In general, working capital financing is easier to arrange than start-up capital, since the underlying certainties are stronger. If you have sold a container of handbags to Chili, there are of course risks, but these can be estimated much more easily of basis of previous experiences.
Working capital need
Let's have a look at tangible products first. If you take the example of selling handbags to Chile, it may be the case that you manufacture them in France. This means that you will have to buy your raw materials, have to pay for people who manufacture them and have to pay for shipment. So far not that different from your normal working process and cash flow management.
The point is that after paying money for these steps your products will go on a boat to Chile and will have to wait there for customs clearance. This may take a long time, perhaps up to two months, and as long as your client has not received the goods, he will not be willing to make payment, except for a partial prepayment when ordering.
For services this is less a factor. For smaller services you can ask for a pre-payment, and you can also create multiple invoicing moment, as long as you can show your client progress. Also there is no time-lag due to transportation.
If you have a relatively constant export revenue, your bank may increase your credit facility to overcome this export-related financing problem. The bank may ask for an interest security on your stock and on the goods that are being shipped.
Key here is to have a stable export stream. Otherwise it may be too much hassle for your bank to examine every individual deal.
International letter of Credit
An international letter of credit is a financial instrument used to overcome the risk between the moment the seller ships the goods and the time that the buyer pays for the goods. After ordering product from the seller, the buyer requests for his local bank to open a letter of credit. The local bank will assess the credit worthiness of the buyer and will issue the letter of credit; this will be in favour of the seller.
As soon as the seller has shipped the goods, and can evidence that the conditions of the LC have been fulfilled, he will receive payment directly from the buyer's bank or through the channels of his own bank. Most risks are usually covered through insurance. As soon as the buyer receives the goods or at an another agreed time, payment will be settled between the buyer and his bank.
Of course the bank issuing the letter of credit will charge a fee for this. There are also many other financial institutions, outside of traditional banks, providing this type of financing.
Factoring companies specialise in paying invoices early. The seller transfers the rights relating to the proceeds coming from outstanding invoices to a factoring house for cash at a discount from the face value. Factoring of foreign accounts receivable is less common than factoring of domestic receivables as domestic lenders prefer to work with companies in the jurisdiction they understand. Depending on the type of clients and the related risks, a company will pay a fee relating to the invoice value with the factoring agency, but will receive their money quicker.
There is a difference between invoice discounting and factoring. Invoice finance is usually used where only selective client’s invoices are discounted and the factoring company usually manages their ledger. However, factoring is usually used to discuss whole ledger discounting of invoices and a finance company managing the invoicing process of a company.
Confirming is a financial service in which a specialised company or financial institution confirms an export order from the issuing bank of the seller. This will be the case when the buyer is not happy with the creditworthiness of the seller bank or jurisdiction and looks for another guarantee from another financial institution. For the exporter, a confirmation means that they will feel more comfortable from a more stable financial counterparty. This will of course mean an additional cost, but increases the stability in the trade.
Plan your financing rounds for your international growth
Your financing needs and the way you obtain funding will vary along the process of international expansion.
- In the orientation phase your costs will be limited to first visits and some market research. This may vary from 10,000 USD for nearby smaller markets to 50,000 USD or more for bigger markets further away. It is hard to get external financing for this, this will have to come from the shareholders.
- In the market entry phase your costs will be higher, e.g. for finding your distributors, for setting up a local office and for initial marketing costs, to get you brand known. This phase you can treat well as a business case. First you can try to lower your costs with subsidies. Then you can pitch with your shareholders, other investors or obtain government backed loans, if these are available.
- When the business starts taking up, you can obtain bank financing or work with letters of credit for bigger orders. In this stage you also know more on the effectiveness of various communication channels, so you can for example predict the outcomes of a new advertising campaign.
Export Finance starts with a good plan and a business case
As mentioned before, in all phases having a good plan is important. And on basis of market research you can build a solid business case to convince investors and banks. Alliance experts has a strong financial focus, and we would be happy to guide you in these steps.