You may not have thought of yourself as a banker, but sales representatives are providers of commercial credit.
By keeping this in mind when entering into or deciding whether to continue or sever a relationship with a principal, a sales representative can minimize the damages it will incur if the principal becomes insolvent, by which I mean unable to pay commissions as they come due. There is always some level of risk that a principal will not pay commissions not out of malevolence, but due to inability. Business failure is always a possibility. The representative cannot do much to affect the principal’s bottom line. However, it can take steps early in the relationship, or even before the relationship begins, to mitigate or control its loss if in the future the principal becomes unable to pay its commission obligation and other operating expenses.
As a sales rep you are extending open account, unsecured credit to your principal. This is inherent in the business model. The rep performs its services at the beginning of a long process which ends either when the customer pays an invoice or when the principal pays the commission on the sale. In most instances the representative’s commission is fully earned and not subject to future offset when the customer pays its invoice. Sometimes the representative’s commission is paid in the month after delivery of the product to the customer, but in those cases if the customer does not pay, the principal can charge back and offset against future commissions due to the representative. The representative performs most of its services prior to the sale, delivery and payment. Most important, the representative is shepherding the sales process to the point where the customer places a binding order for the part or product sold by the principal. All of that work is complete long before a commission ever becomes due and payable.
Borrow Best Practices
Sales representatives would do well to draw upon principles and techniques used by commercial lenders and apply them to their relationship to their principals in those areas of the relationship that involve extensions of valuable services by the representative to the principal as unsecured credit. The commercial lender is concerned about two issues that should also concern the sales representative.
• Is the borrower an enterprise the bank wants to go out on a limb for by making a loan?
• How can the bank mitigate the loss which may occur if the borrower’s business is unable to repay the loan? It does sufficient due diligence to reach subjective and objective conclusions about the borrower’s management and its business. These concerns can be described as underwriting and salvage.
In performing the underwriting function, the representative has to evaluate and judge the quality of the principal’s business. The specific issues to be investigated include (a) the quality of the product or service provided; (b) whether the principal has any expertise (including human resources/human capital) or capabilities that give it a competitive advantage over providers of the same products or services in the marketplace; (c) the quality of the principal’s administrative operations; (d) the competence of the executive decision makers in areas of business management and administration; and (e) the financial condition of the principal. Essentially, you are asking two related questions. Do I want to do business with this principal? Does this principal have the ability to honor its obligations to me? In answering these questions you have to make subjective evaluations about the people who own and operate the principal based upon a critical look at available information.
Performing Due Diligence
One should approach this endeavor with the understanding that you are not going to have full and perfect information about the principal’s business. Yet, if you keep the underwriting issues in mind at the outset, you can engage in meaningful due diligence about your principal. Knowing what underwriting questions you are seeking answers to will help you focus what you want to accomplish in your site inspections and discussions with the principal’s owner, estimator, producing manager and sales manager. In addition to selling yourself during this pre-contract courtship, you are trying to assess whether there is a market for whatever it is the principal has to sell. Equally important, can the principal sell the product at a price that is competitive and includes enough margin to pay a full commission?
Whether you are or will be replacing a prior representative, it is always useful to know how and why the prior relationship ended. You should hear that story told from the perspective of both the principal and the prior representative.
It is always useful to keep in mind that the skills that make a person a skillful tool and die maker, machinist, salesman or production manager do not immediately translate to the finance, management, administration skills necessary to operate a business profitably and efficiently. A business that uses sales representatives does so because it recognizes it does not have the resources or expertise to make and implement a successful marketing program. It makes the economically rational decision to outsource that function at least until it matures to the point at which internally managed sales produce a net profit that exceeds what was achieved by using outside marketing. The question for the sales rep at the outset of a prospective relationship is whether the owners of the small- to medium-size principal bring the same rational perspective to finding competent administrative, fiscal and management personnel as they do to finding and managing capable outside sales representatives. Sales representatives, like banks reviewing a loan application from a new business borrower, have to do whatever can be done to assess the quality of the total business operation of a principal in order make an informed decision on whether to assume the risk of nonpayment of commissions.
There are ways to kick the tires at a reasonable expenditure of time and money:
• Make the most of the visits to the principal’s business. Try to speak with the CFO and accounting staff. They are the people who take care of billing and collecting on your orders and account to you for the calculation and payment of what is due to you. Find out what type of bookkeeping and accounting software is being used to track orders received, shipments, billings, collections and commission calculations.
• See what you can determine about pricing and estimating. It has become apparent over the past five years that many businesses are pricing their products and services at unrealistically low margins or at break-even or below cost, just to generate a cash flow, albeit negative. This is usually a throughway to disaster for both the sales representative and the principal. Although the appropriate response to an operating loss is to find more capital, become more efficient and improve the business model, the typical struggling business commonly just stretches out the trade vendors as the path of least resistance, and the sales rep is seen as just another trade vendor.
• Determine if there are too many spouses, children, in-laws and cousins in administration. There is nothing wrong with hiring family, but at some point it becomes obvious that finding competent people is playing second fiddle to nepotism.
• Examine the form of monthly accounting statement that the principal gives to its representatives.
• Review from publicly available data bases the status of pending and past litigation, federal and state tax liens, and UCC financing statements. The existence of financing statements is a positive indicator. It shows that the principal has passed the underwriting criteria of capital equipment or working capital lenders and may have the ability to draw on a credit line during a cash flow crisis.
• For a few hundred dollars you can obtain financial information from Dun & Bradstreet that is not contained in the public databases.
The best predictor of a successful or troubled relationship may be the conclusions you draw based upon your accumulated experience and applying good judgment to what you glean from meaningful conversation and keen observation. Have you determined whether the principal really values the service the sales representative provides? Does the principal value its own business enough to bring the capital and expertise needed to enable it to succeed? Do the principal’s executives have the intellectual and emotional flexibility to adjust to a business environment that may change at any moment? Just modify these questions slightly and they are probably the same questions a good sales representative is asking itself periodically in trying to figure out how to operate better and more successfully.
Intelligent underwriting for a sales representative can minimize the risk of getting into a bad relationship. However, even good people who operate a well-run business can experience downturns that will make it difficult or impossible to pay the sales representative the commissions owed as they fall due. In part two of this article, again drawing upon techniques prevalent in commercial lending and restructuring of defaulted debt, I will review how to mitigate potential loss at the contract formation stage, and how to aggressively manage and cope with what has become a losing proposition for the sales representative.