Understanding LPO financing for small business owners

Starting a business requires capital, yet you won’t always have enough to turn your dreams into reality. Still, a lot of entrepreneurs don’t let that stop them.

So what happens if you approach a client, secure an order for products worth, say, Sh1 million, but don’t have the money to purchase these goods and then sell them on? That’s where LPO financing comes in.

A Local Purchase Order (LPO) is a legally binding document that indicates the items a client agrees to buy from a seller at a specified price and time.

An LPO document can be used in financing contracts, and with it, vendors or entrepreneurs can obtain business funding that will aid in fulfilling the contractual work stated in the order. Most banks and microfinance institutions in the country offer LPO financing, though they consider a number of factors before agreeing to lend out the cash. These factors include:

1. Credit score

The credit score of a person or business helps determine their creditworthiness. Financial institutions conduct an extensive review of your business, books of accounts and loan repayment behaviour before they determine the terms that will govern the LPO financing they’ll extend your way.

2. Amount of money required

The financing you receive will largely be based on the level your business is at, your inventory and your sales. Larger businesses tend to be better able to repay their loans than smaller firms, so they’re more likely to attract larger financing. Financial institutions will weigh the amount of money you require against the size of your business in terms of the assets it has. This will then be used to determine whether your business is able to repay the loan or not should the LPO fail to work out or the buyer be unable to pay. A bank may also first ask to value your assets so that in case of default, they can acquire them as collateral.

3. Your banking history

Most financial institutions require you to have banked with them for a certain period of time – mostly six months – before they can give you a loan. This way, they’re able to generate a history of your transactions and the state of your cash flow. Some institutions will allow you to present a statement of accounts from a different bank, as long as it shows a substantial transaction history.

4. The reputation of the buyer

For LPO financing, lenders will generally need to examine the credibility of the institution you’re in business with to determine their ability to honour their contractual obligations and pay you so you can pay the bank back.

If you’re considering LPO financing, first create good rapport with a financial institution. This may mean taking advantage of their other products, such as overdraft facilities, to show your creditworthiness. Don’t change accounts too often and keep your transactions regular to create an attractive history.

You can also consider alternative financing options, including Saccos, Government initiatives like Women Enterprise Fund and Youth Enterprise Development Fund, and foundations like Citi Foundation or Chandaria Foundation.