May 19, 2019

Private and White Label Vendor Finance in a Shifting Market

Significant changes in the environment have provided an opportunity for software vendors to make it easier for customers to acquire their software:

First, software license models are changing, moving from on-premises perpetual licenses to usage-based subscription models.

Vendor objectives are also changing, moving from a focus on upfront revenue recognition to recurring revenue streams.

Software accounting rules are also changing.  SOP 97-2 has been replaced by IFRS 15 and ASC 985606.

This shifting market has had a marked impact on private label software finance.  Private label financing simply means that the vendor provides the financing directly to their end users.

Changing path
Photo by Kimi Lee at Unsplash

Under SOP 97-2 private label financing made revenue recognition challenging for many vendors.  In order to take upfront revenue recognition, vendors lacking a defined history (an established track record of extending terms, successful collections over time and no concessions made during the term of the financing) had two financing options:

  1. Provide extended payment terms and defer revenue, or
  2. Provide third party financing where customers enter into a financing arrangement directly with a financial institution (bank or leasing company). Third party financing has a lower acceptance rate than private label financing. End users prefer to contract with the vendors directly, not with a third party.  Customers had concerns about the third party infringing on use of their license, or the financing institution involvement in the license chain, and they viewed the financing as a loan, or debt.

Under new IASB and FASB accounting rules, however, customers are capitalizing their financing commitments on the balance sheet.  Hosted subscriptions are treated as operating expenses (see John Chasse’s blog on capitalizing the cloud).  Vendors may take upfront revenue on on-premises subscriptions financed via private label financing programs.   We have seen a significant uptick in the demand for these private label programs from vendors, and in even greater numbers, from the value-added resellers and distribution companies.    Why?

The Cloud, Cash Flow and Risk Mitigation

Vendors and channel partners have been accustomed to receiving upfront cash for multi-year transactions.  Cash flows are impacted significantly as billings move from net 30 to payment over time.  Private label financing allows the vendor and the channel to accelerate cash and to transfer the credit risk from end users to financial institutions.

Although most private label financings are assigned to financial institutions for billing and collection, private label financing is generally viewed by the end user as vendor payment terms versus a loan.  Private label financing and vendor-provided internal payment terms are perceived by a customer as one in the same.  However, private label financing provides vendors and the channel with an opportunity to mitigate risk and to accelerate cash programmatically.   Internal payment terms, those embedded in the sales or license agreement, do not.

Below are some of the benefits of private label financing programs:

  • Maximize customer acceptance of binding multi-year agreements
  • Maximize revenue and mitigate discount pressure
  • Provide a low fixed cost of capital
  • Simplify & standardize sales processes with deal desk, sales management (one selling motion)
  • Reduce sales friction–one path, one selling motion

Vendors and channel partners can have the best of both worlds.  They can elect to hold certain transactions internally to bill and collect over time, while leveraging their private label programs to accelerate cash, manage risk for other transactions.

Flow chart

Key Takeaways

  • Under private label financing arrangements, vendor and channel partners have the flexibility to manage cash and risk at time of sale and throughout the life of the contract.
  • NEGOTIATE the program agreements carefully! Make sure the language allowing for the non-recourse assignment of payment terms meets true sale treatment from legal and accounting perspectives.
  • Ensure that financial institutions are not demanding excessively broad reps, warrants and indemnities.
  • Private label financing works for cloud, subscription and perpetual licenses.
  • The timing of cash flows from the financial institution to the vendor or channel partners may be upfront or annually in advance.

Thanks to these changes, private label financing has never been easier—which is a great opportunity for vendors, channel partners and customers. Please let us know if we can provide any guidance or assistance as your organization adapts to these changes in the market.