Capital Gains: The Return of Channel Financing

After several years of painful credit crunches and capital droughts, solution providers today say money is flowing into the channel again.

And perhaps the biggest driver behind the channel financing renaissance is the overall improvement in the financial health of solution providers. Vendors and distributors generally agree that solution providers today are more stable and, better yet, profitable. Part of that has been a shakeout of weaker, unstable solution providers following the economic downturn in 2009, said Scott Tillesen, vice president of credit and customer care for the Americas at Tech Data.

"There's definitely been a maturity increase in the industry when it comes to financials," Tillesen said. "The partners that were able to weather the downturn have come out stronger, so I think the health of the channel has greatly improved in recent years."

[Related: Channel Financing Week ]

Financial analyst firm Raymond James recently issued a research brief that showed channel companies (including distributors) outperforming vendors in revenue and earnings per share over the last two quarters. A big driver for that trend, according to the report, is that businesses typically rely on channel partners during "periods of rising complexity" due to new technologies such as cloud, virtualization and mobility.

Another factor is how solution providers are viewed differently today. Erik Bodor, director of information technology at cloud solution provider GSATi in Denton, Texas, said his company ran into challenges in 2009 and 2010 trying to find financing when it wanted to build its own data center for private cloud services. The reason? Financiers were focused on the actual assets and not the company's potentially lucrative services model.

"Nobody would give us a loan for hardware purchases," Bodor said. "The servers were fixed assets that weren't going to appreciate in value, and they weren't interested in our business model."

But now things are different. Frank Vitagliano, vice president of North American channels at Dell, said that while financial metrics are still important, a solution provider's business model takes precedence. "I think what ends up getting looked at [today] is not so much the asset, but the business model and what's being driven in the business model," Vitagliano said.

Not only is there more money available and more interest in solution provider business models, but the options and quality level also have increased.

David Ruchman, chief technology officer at Powersolution.com in Ho-Ho-Kus, N.J., has noticed a big difference in the amount of money available to channel partners such as Powersolution.com. Five years ago, one of the company’s top distributors unexpectedly cut Powersolution.com's credit line -- not because the solution provider was in financial trouble, he said, but because the distributor reduced its available credit across the board.

"We saw a big pullback from financing in 2009," Ruchman said. "We had our credit line dropped by one of our top distributors, which made things difficult."

But today, things are much better. While Powersolution.com offers cloud and managed services, it continues to provide servers, PCs and network appliances to its clients. Virtually all of the products are sourced through distributors, primarily Tech Data, which Ruchman said offers favorable credit terms and financing options.

"We're trying to push our clients to get into the cloud, but we still sell a lot of hardware and we're not going to leave that money on the table," Ruchman said. "Financing is a lot better today. It's not going to be like it was 15 years ago when vendors and distributors were literally handing out thousands of dollars just for signing up for a financing offer. But it's a lot better."

Vendors and distributors say more solution providers are taking advantage of financing today. For example, Lenovo recently said the number of resellers using the vendor's 60-day interest-free financing jumped a whopping 40 percent year over year during the company's most recent quarter.

There also are different financing options and services available today. Those options include utility financing with consumption-based billing in public, private and subscription-based cloud services, and partnerships with vendors in various risk management strategies (which are typically under NDA with the vendor) that result in more credit being available to a solution provider for pre-funded leases (or funding prior to acceptance by the end-user customer).

Bob Stegner, senior vice president of marketing at Synnex, said alternative financing has become a competitive differentiator and that more solution providers are participating in the new offerings. "We typically have $500 million in credit available for active customers," Stegner said. "Alternative financing options, excluding floor-planning, has contributed more than $300 million in sales over the last 12 months. So alternative financing definitely has teeth in the channel."

NEXT: Big Financing Moves From GE Capital, Wells Fargo

Even though many solution providers these days are focusing more on services and less on product, they still need the occasional influx of capital to seal a client deal.

Todd Plambeck, vice president of technology at Bedroc, a solution provider based in Franklin, Tenn., said his business is mostly self-funded and generally doesn't need to secure financing from third parties. But there are exceptions, and in those cases he's been able to lean on a trusted partner.

"We generally didn’t have to go to the bank to get bigger channel funding to support our business until recently because we needed to hire about 30 people in 30 days for a particular project," Plambeck said. "So we work with GE Capital, and they're great. They do what they say they're going to do, and they extend our credit when we need it."

Plambeck said Bedroc chose GE Capital as a financing partner because, unlike a bank, they understand the channel and the solution provider business. "They do know about our industry and that’s helped out a lot," he said. "We see banks trying to get our business but they are new to this business and don't understand it the same way."

While distributors have been a major source of financing for years, the rebirth of capital in the channel also can be attributed to other players that have taken a growing interest in the solution provider business model such as GE Capital and Wells Fargo.

For example, Dell recently partnered with both GE Capital and Wells Fargo to increase its interest-free financing period from 30 days to 60 days.

Robert Wagner, managing director of business development for Wells Fargo's Supply Chain Finance Group, said the organization is involved in $15.5 billion worth of transactions in the channel annually.

"Five or six years ago, it was an interesting time because there wasn't a lot of financing options and there were a lot of companies that were struggling to stay afloat," Wagner said. "There aren't a lot of banks that do this. It's a small universe. Vendors don't typically want to deal with 10 or 12 different financing partners, and other banks and financial services firm don't really know the channel."

Wagner said Wells Fargo is definitely seeing the move to services and recurring revenue models in the channel. "The mix we see right now is about 60-40 product to services, and it's trending down for product revenue," he said.

Wagner said Wells Fargo also is seeing growing interest from other vendors besides its current partners like Dell, Cisco Systems and Hewlett-Pakard, and that additional partnerships are in the work. "We're covering the market from top to bottom," Wagner said.

The 60-day interest-free financing option is becoming more common today, according to vendors. During a roundtable discussion of channel chiefs with CRN editors earlier this month, Edison Peres, senior vice president of worldwide channels at Cisco Systems, said the extension to 60 days is valuable not because solution providers don't have money but because they want to use that available cash to grow the business.

"Most of the time that cash flow is what they're using to invest back into the business, so it's less because they're trying to survive," Peres said. "If I'm a VAR, now I have 30 days worth of cash flow that I can invest back in the business. And that's what we try to stimulate."

NEXT: New Channel Models, New Financing Options

Tech Data's Tillesen said channel financing has evolved in recent years, thanks to industry shifts around managed services and cloud. For example, he said Tech Data has seen a small shift away from floor planning (third-party financing for additional credit) and a growing interested in leasing options (including leasing directly to the customer if the solution provider prefers).

"I think the financing options today are better aligned to the reseller's needs, whether they're doing product or cloud or managed services," Tillesen said.

Vendors also are trying to adapt their financing strategies to services trends in the channel; Unitrends, a data protection and backup appliance maker based in Columbia, S.C., is one such vendor. Last summer the vendor launched its Service Provider Program for hosting, cloud and managed service providers, which enables those partners to purchase the hardware appliances and build their own private clouds.

Unitrends CEO Mike Coney said the program lets solution providers buy the Unitrends Recovery appliances and pay the purchases off on a monthly basis; that way, they can avoid big capital expenditures and cover the cost of the hardware in a manner similar to their own recurring revenue model.

"If partners are using a recurring revenue models," Coney said, "then we want to help them and deliver the product to them in flexible model."

Still, as VARs shift more toward their own services and rely less on product sales, they'll need help from finance partners to make the transition from capital expenditure sales to smaller, recurring revenue from operational expenditures. Paul Bay, president of Ingram Micro North America, said it's a challenge for solution providers to, for example, move from $100,000 a month in product sales to just $3,000 or $4,000 a month in recurring services revenue.

"We're seeing more and more requests from partners who say, ’Can you help me bridge that gap between my physical goods sales and now my recurring revenue sales from a cloud standpoint or a services standpoint"," Bay said. "I think those financing options will continue to change and develop on the needs of their businesses. Being able to help subsidize and support them [in their transitions] is important."

For more on how financing options are adjusting to recurring revenue models, stay tuned for Part 2 of our Finance Week Series.