Join us, Tuesday, June 21, 1pm ET for a conversation on the potential of supply chain financing.
Supply Chain Finance: Innovations for Supporting Inclusive Entrepreneurship
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A shift to a more inclusive economy requires financial innovation and new tools to reach more entrepreneurs excluded from current capital products. This is the basis of the Innovative Finance Project, announced last spring, a partnership between the Nowak Metro Finance Lab and Blueprint Local funded by the US Economic Development Administration to identify and scale innovative methods of small business finance. This work is more critical than ever with interest rates rising, an influx of investors targeting Black and Brown neighborhoods, and more public dollars for transformative small business investment soon set to flow.
Perhaps the most promising financing tool is grounded in strengthening suppliers, the potential of B2B and B2G purchasing, and unlocking the procurement economy: Supply Chain Finance (SCF). SCF is a tool to maintain critical cash flow across supply chains, deliver capital more effectively to underserved entrepreneurs, and, ultimately, grow diverse-led businesses. Any focus on supplier diversity is incomplete without an in-depth capital conversation; our inquiry has led us to Supply Chain Finance, a key tool for supplier capital access.
The Innovative Finance Project will host a webinar, Supply Chain Finance: Innovations for Supporting Inclusive Entrepreneurship, this Tuesday, June 21, at 1pm ET, to detail the basics and history of Supply Chain Finance, current applications and examples of SCF products, and SCF innovations and interventions practitioners would do well to test and scale.
Supply Chain Finance: A Brief Overview
Supply Chain Financing is one of the most important ideas in innovative finance, but also among the oldest.
The ancient Phoenicians used SCF as a tool to stimulate trade across the Mediterranean, providing capital to merchants in advance to finance production of textiles, wine, and other goods. Similarly, today, global financial markets have created an array of SCF tools to bring liquidity across global supply chains, primarily through early payment directly from buyers or third parties providing capital before receipt, purchasing receivables.
The logic of SCF is simple: use contracts for goods and services (i.e., the promise of future revenue) to underwrite the provision of capital to businesses. Its implications are nonetheless far-reaching, and the concept has been largely underutilized in providing capital to underserved entrepreneurs, especially in the U.S. market.
Most critically, SCF is a sharp departure from asset-based lending and other forms of small and medium-sized enterprise (SME) credit that focus on the collateral and creditworthiness of SMEs themselves. SCF instead focuses on the creditworthiness and ability to pay of the buyer, who oftentimes is a more established entity such as a large corporate or government. This expands the short term borrowing capability of firms and entrepreneurs without “friends and family” money, unlocking a new source of capital for the 83 percent of entrepreneurs who do not access traditional bank or venture capital.
The application to SMEs trading within U.S. borders is the crux of the innovation, rather than the use of SCF itself. SCF is currently used extensively across global supply chains to keep international commerce flowing, just as it did in the Mediterranean millennia ago. The use of SCF has grown significantly in recent years with increased globalization and new technologies for seamless and secure online transactions. However, confusion around terminology has led to the formation of the Global Supply Chain Finance Forum and its typology of SCF techniques to unify the field around common terms.
Despite its growing global importance, SCF has yet to take root in the United States’ domestic supply chain, especially in supporting under-served entrepreneurs in domestic American B2B and B2G markets. This is a great irony given the U.S. position as a global leader in finance and technology and its role in establishing SCF systems internationally, such as in Latin America, which today is a leader in SCF.
Herculean U.S. efforts to finance and bring cheap goods home from overseas have overlooked businesses and local suppliers within the same zip code. Efforts to re-shore production following pandemic-induced global supply chain disruptions and address racial inequities by boosting Black businesses in the wake of George Floyd’s murder converge on SCF as an ideal tool to channel local market-making purchasing and demand towards long overlooked BIPOC-owned firms.
Challenges and Opportunities to Build Wealth
The lack of supply chain financing in the U.S. reflects a segmented economy, where contractors are on their own to find capital to fulfill bids that represent a turning point in their growth trajectory. The Procurement Economy remains low-tech, under-developed, and under-financed for no clear reason except for lack of attention from traditional banking institutions.
We see isolated cases of SCF products in public and private sectors — public authorities experimenting with contractor-support tools or third-party, fintech companies providing financing to businesses looking to meet large orders or contracts. The US Export-Import Bank (EXIM) as a public institution, for example, has a Supply Chain Finance Guarantee Program for large exporters to pre-pay its U.S.-based small business suppliers through third-party private lenders, providing critical working capital to small suppliers and supporting export growth.
Additionally, the first iteration of the State Small Business Credit Initiative (SSBCI) a decade ago spurred some promising developments in this space. Florida used its SSBCI funds for a supply chain finance working capital product similar to EXIM’s — a loan guarantee program to support Florida-based small businesses seeking working capital to fulfill international contracts but ineligible for EXIM and SBA loans. Most notably, New York State successfully used its SSBCI funds to create its Bond Guarantee Assistance Program (BGAP) to increase minority- and women-owned business enterprise (MWBE) contracting, providing guarantees to surety companies underwriting contracts state and city. Paired with a working capital product to help recipients meet contracts and tap into local networks and chambers, New York met and surpassed its goal of doubling MWBE representation in just two years, increasing MWBE contracting from 9 to 21 percent between 2011 and 2013. These bright spots however are yet to be widely adopted. The SBA’s Bond Guarantee Program, for example, remains underutilized.
The need for SCF is most evident in construction, a sector with relatively high rates of minority business ownership and large volumes of procurement dollars. It’s also the sector with the longest period for firms to receive payment, averaging 73 days. The further businesses are down the supply chain, the more this crunches cash flow: as primary contractors wait to be paid by funders, sub-contractors must wait to be paid by primes, and subs of subs wait to be paid by everyone. This lag creates a wicked problem as the least creditworthy are the most in need of credit, and many minority businesses struggle to scale into prime contracts. And this is just construction; without SCF-type financing, businesses who aren’t eligible for a traditional bank loan won’t have the capital they need to scale, and they are less likely to take on jobs that would help them grow.
Built appropriately to create access to affordable credit, SCF is a tool that can help smaller B2B and B2G firms fulfill orders and contracts that grow their businesses. With participation from impact investors, public institutions, and other patient capital, SCF can provide an affordable and intuitive alternative for historically underrepresented businesses looking to seize an opportunity, grow their firms, and build generational wealth.
Bruce Katz is the Founding Director of the Nowak Metro Finance Lab at Drexel University. Aunnie Patton Power is a lecturer at the University of Oxford and the author of Adventure Finance. Ian O’Grady and Elijah E. Davis are Research Officers at the Nowak Lab.