Changing market demands are forcing transition in the vendor finance marketplace. What was once a simple sales finance tool used to
facilitate the acquisition of capital equipment using firm-term contracts such as leases, loans or equipment finance agreements is now becoming increasingly more complex.
In the past, the selling vendor worked with its customer to finalize equipment configurations, deliverables, timing and pricing. The vendor finance partner would either contract directly with the end-user customer under the terms of a referral program agreement in place with its vendor partner or take assignment of a contract executed directly between the vendor and the end-user, utilizing a private label master assignment agreement between the vendor and its finance partner. Referral agreements and assignment agreements are both forms of vendor program agreements.
A vendor program agreement (VPA) is a set of rules by which vendors and their finance providers agree to work together. The increase in transactional complexity that bundles hard assets, software solutions and services delivered over time require a new type of VPA. Today, VPAs are becoming more complex and more intricate, requiring vendors and their financing partners to reconsider how they conduct business.
Managed Solution Transactions
In the Winter 2017 edition of the Journal of Equipment Lease Financing, produced by the Equipment Leasing & Finance Foundation, Paul Bent, senior managing director for The Alta Group, wrote a piece on managed solution transactions (MST), in which he questioned whether the venerable hell-or-high-water clause will remain viable and enforceable for MSTs.
Managed solution transactions are truly complex sales. For example, a copier dealer may view a managed print services contract as the sale of certain equipment, accessories, installation, maintenance and consumable supplies to be delivered over the course of the contract life. The end-user views the same contract as a fee per click — a utility cost for printing and copying. The more it is used, the more it will cost. Likewise, the less it is used, the less it will cost. The buyer doesn’t see it as buying equipment, toner and paper — they see it as buying printed material.
The copier business is somewhat predictable. Using historical data of actual print counts, toner usage and paper consumption will allow a dealer to make an educated guess as to what a company’s future printing needs might be. The contracts generally include firm payment amounts for the equipment along with a minimum monthly or quarterly print count enabling the dealer to sell the deal to their vendor finance partner for the cost of the hardware, installation, annual maintenance costs and the present value of the monthly minimum print count. Overages and under-usage can be reconciled periodically as agreed between the parties and pass-through billing for the consumables can be facilitated by the finance company with cash forwarded to the vendor as collected. Neither the vendor nor the finance partner is really on the hook for excess risks associated with this type of transaction. Predictability reduces the risk.
What if the MST was less predictable and the solution included products and services delivered by multiple vendors? Consider an enterprise software solution being delivered by a systems integration consulting firm to a FORTUNE 500 company with the solution to be run on the hardware of a major brand vendor delivered via the cloud. The enterprise solution may have a fixed price or a subscription cost, or the cost may be based on the number of seats expected on day one with accelerators priced in to account for headcount growth over time. What if the hardware, spec’d by the hardware vendor, fails to perform adequately? What if the hardware vendor blames the performance issues on the software developer? What if the only executed VPA is between the systems integration consulting firm and the vendor finance provider? It is easy to see how the FORTUNE 500 company might be reluctant to sign any type of master services agreement that included hell-or-high-water provisions precluding them from withholding payment when all hell breaks loose.
So Long Hell or High Water
The assertion made by Bent that the hell-or-high-water clause may go by the wayside seems to be coming true.
Last summer the Equipment Leasing & Finance Foundation commissioned The Alta Group to produce a study, “Managed Solutions: Evolutionary or Revolutionary?” The study effectively described the transition affecting our industry — driven by customer demand — moving from traditional non-bundled solutions to partially bundled, bundled in appearance and finally evolving into true service offerings. Unlike the managed print services example cited earlier, true service offerings can be developed in many different forms. What we label MST could just as easily be a managed services agreement, a telecommunications-as-a-service agreement or even computing on demand — a term introduced by IBM in 2003 in an effort to compare a company’s need for increased computing power to its need for increased electricity, a utility that is made readily available but only paid for when used.
Business customers are demanding that suppliers provide access to a broad range of required services and make them available for purchase as needed and when needed. These evolving customer requirements are driving the Uberization of vendor finance. The standard VPA that our industry has been using for years may be obsolete when it comes to governing MSTs.
Utility-based end-user contracts include provisions for service level expectations. If those expectations, dictated by a statement of work or a service level agreement, are not met, customers have contractual rights and remedies, which may include cancellation without penalty. What finance company is going to take on the performance risk of a service provider without recourse, repurchase or some other form of financial support? Perhaps a captive that has skin in the game might take the risk, but not a bank or traditional commercial finance company.
Next Level VPAs
For the past several decades VPAs have included boilerplate language governing the transactions purchased under the program. Standard qualifiers include details regarding customers, the credit review process, communication of credit decisions, documenting of the transaction, delivery of the equipment, its acceptance by the customer, commitments that all products have been delivered and all obligations fulfilled. VPAs include representations that clearly separate the obligations of the vendor from those of the finance partner. Traditional VPAs also include vendor representations that all contracts are valid, enforceable and non-cancellable, and that no side agreements exist. VPAs required the vendor to provide indemnification to the finance partner protecting against claims, losses or liabilities arising from defects or damages caused by the equipment, acts or omissions of the vendor or its employees that cause harm to the finance partner, or any breaches of the VPA by the vendor resulting in losses suffered by the finance partner. Any breach of the various representations, warrants or indemnifications could represent an event of default as defined by the VPA. A common remedy for default may include repurchase by the vendor of an impacted transaction or of the entire vendor finance portfolio.
VPAs are not to be taken lightly. They symbolize the seriousness of the relationship between the selling vendor and its finance partner. However, as customers demand more utility-based products and services, the traditional VPA must change to accommodate these requirements. Where in the past, firm-term contractual commitments were the norm, the future will require flexibility to increase or decrease the number of products or services delivered at any given time.
For vendor finance providers, the process of credit underwriting a new vendor selling MSTs will require a longer-term view of the vendor and any service provider partners’ ability to satisfy the needs of the customer over the course of their relationship. Instead of ascertaining that the equipment and accompanying soft costs have been delivered and installed as of the commencement date, the finance partner will need to assess the ability of any service provider to continue to satisfy the ongoing and future needs of its customers. In some instances, this will include the assessment of a service provider’s ability to manage the aggregation of service commitments to multiple customers. For the vendor finance partner this will require an increased level of scrutiny to be certain that service provider partners have sustainable business models and legitimate staying power.
The asset management teams for vendor finance providers must be keenly aware of the increased likelihood of assets returning before their scheduled end of term. Working in partnership with their vendors, secondary uses for returning equipment will be identified to maximize residual economics, without laying all the risk on the end-user customer.
Salespeople will need to be conscious of the tighter underwriting requirements when prospecting for new vendor relationships. They may need to forego the low hanging fruit represented by smaller service providers who may be enamored with the idea of partnering with a big finance company. Instead, they should focus on the stronger, more mature and well capitalized providers who will be around to deliver on their future commitments.
According to Stephen Hawking, “Intelligence is the ability to adapt to change.” Our industry will need to adapt to the new way of doing business in vendor finance. The VPAs and underlying transactional documents may lose some teeth, but we will find a way, just like we always do. Because according to the earlier referenced study, “MSTs will reach more than 22% of total U.S. equipment leasing volume over the next three to five years.” That equates to more than $250 billion of the estimated more than $1.2 trillion total U.S. market by 2019. The evolving range of MST-type products are certainly worth paying close attention to.
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One Reply to “The Uberization of Vendor Finance: Customer Demands Force Reassessment of Vendor Program Agreements”
Second time I read this, Dexter. Informative, timely, interesting. Well done.