Protecting Your Business, and Your Bank Account, in Case Clients Don’t Pay

After nearly two decades in the packaging industry, Izzy Eisenberg figured there was a need for more complicated specialty packing products — or as he put it, “the things that other people don’t like getting involved in.”

He was right, and the business he started, Packaging Methods Defined, took off. What worried him, though, was that most of his revenue came from three or four large clients. If one of them didn’t pay — or was even overly slow in paying — his business might have been at risk of failing, taking his personal wealth with it.

“The amounts were so high I didn’t feel comfortable,” Mr. Eisenberg said, remembering that time 13 years ago. “Luckily, nothing happened when I first started.”

After three years in business, he had enough of a track record to get credit insurance, also known as receivable insurance, to insure what buyers owed him. Since then, he has had four claims, including a large one that would have been a financial blow to his company. The insurance carrier paid them out or otherwise resolved them.

Last week, I wrote about how business owners, whose wealth is tied up in their private companies, can raise money to buy out partners or acquire other businesses. Yet before getting to that stage, entrepreneurs often need to protect their companies — and their personal wealth — in case a client doesn’t pay its bill. And it would be impractical to keep so much cash in reserve.

This is where so-called limits insurers come in, offering coverage to firms with annual revenues of $1 million to $20 million.

Euler Hermes, a limits underwriter, recently introduced a plan called Simplicity, aimed at helping businesses with $1 million to $5 million in sales. Another insurer, Coface, offers the International Policy, an industry favorite, that is meant to be easy for a midsize business to buy and use. The policy looks just at the top accounts and insures the rest with a blanket policy.

“Everyone is good until they’re not,” said Victor Sandy, executive vice president at Global Commercial Credit, an insurance broker. “You take a hit on receivables, it comes right out of your bottom line, or your retirement money.”

Bill Hawkins, founder and president of Compatible Cable, a cable distributor in Concord, Calif., said he got receivable insurance after a client he had worked with for a long time shut down and he wasn’t paid. He said he had revenue from a lot of accounts so it wasn’t devastating. But he said he started thinking about what would happen if one of his larger accounts went out of business.

“We’d never had any customers go out of business,” he said. “The insurance isn’t cheap. You have to stop and weigh the benefits of it.”

James Daly, president and chief executive for United States operations at Euler Hermes, said that rates varied, but someone insuring $1 million in receivables through the company’s Simplicity plan could expect to pay an annual premium of around $7,000.

“It’s designed to cover you for the bumps in the road,” Mr. Daly said. “It’s not designed to create total coverage. We know if you have one loss on $1 million in sales, it could be enough to put you out of business.”

Michael Chen, president of Myco Furniture in Houston, said he had been using factors — groups that buy a company’s receivables at a reduced rate — but switched to credit insurance through Euler Hermes as a way to cut costs and be more selective in what the company insured.

His company, which manufactures furniture in Asia and sells it in the United States, was able to insure about $5 million in receivables out of annual revenue of $15 million to $25 million. Mr. Chen said the cost for what it insured was half of a percent, down from the 2 percent on all of its receivables that factors charged.

“It’s more peace of mind,” Mr. Chen said. “That way, we don’t get burned on a large account. If we’re insuring $300,000 a month and one of those accounts files for bankruptcy or just doesn’t pay, we’re not out that money.”

Parker Freedman, president of ARI Global, an insurance broker, says that credit insurance is the last thing on most business owners’ minds, and that few think of it until they or someone they know encounter a loss.

“Is there a line in the sand that could hurt your company?” he said. “A loss that could hurt the company varies by the size and profitability of a company. The loss of $50,000 or $100,000 is going to be viewed differently by a $1 million company and a $20 million company. You try to figure out when does a loss get your attention.”

Yet Mr. Sandy pointed out that sometimes even the most seemingly secure companies fail to pay. That, he said, was the case with Target Canada, which filed for bankruptcy and left many of its vendors unpaid. “Just because they seem big and strong doesn’t mean they are,” he said.

For many entrepreneurs, credit insurance has other uses beyond covering payments. The firms that offer the insurance to smaller businesses have databases on the creditworthiness of companies all over the world.

“We meet new companies all the time, but we don’t know anything about them,” Mr. Hawkins said. His insurer can quickly check the creditworthiness of those businesses.

Mr. Chen said Euler Hermes’s database of 55 million accounts had helped him increase his sales. “If the customer was only approved for $10,000 to $20,000, Euler could say this is a creditworthy account,” he said. “We can approve them for $100,000. We can tell the salesperson that this company is creditworthy.”

Kerstin Braun, executive vice president of Coface North America, said that credit checking was useful to companies looking to expand internationally. “We can say we know this buyer and you shouldn’t ship, or we know this buyer and, yes, you can ship $500,000,” she said.

The insurance, which generally guarantees about 90 percent of the value of the receivables, essentially stripping out the profit, can help entrepreneurs increase what they can borrow from banks.

“If you’re pledging your receivables, you might see anywhere from 75 to 80 percent advance rates,” Mr. Sandy said. With insurance, if you’re at 70 percent and the insurance covers 90 percent, the bank can increase its advance rates. It’s better leverage of the same assets.”

Ms. Braun said even if a company didn’t need to borrow, the insurance could allow it to reduce the amount of money it needed to keep in reserve to cover bad debts.

There are limits, of course. A business will encounter one of those if it tries to insure only its worst credits, Mr. Freedman said. Most credit insurers reserve the right to bill for unexpected court costs, he said.

Mr. Eisenberg said he was in a situation several years ago where a billion-dollar company had filed for bankruptcy. Its lawyers were demanding that Mr. Eisenberg’s company, which has annual revenues of $2 million to $5 million, return money it had been paid.

“I tried to negotiate on my own, but I’m this little hole in the wall,” he said. “Because they were an extremely large company, they were able to come to me and say I had to return the money they had paid me in the last 90 days.”

Mr. Eisenberg would not disclose the company or the exact amount at issue, but he said it was “significant.” He was covered through a Euler Hermes policy, and he turned to the company to negotiate on his behalf.

“There was no way I could have done it on my own,” he said. “Some of the other companies that were small, they’re not around anymore.”

And their collapse surely affected their founders’ wealth.

This article was originally published by NY Times.