Mitchell Compton II’s success was starting to freak him out. He cofounded the San Diego-based Coconut Beach, which sells a line of coconut chips and drinks, and debuted the products at a natural-foods trade show in March 2015. Orders came in rapidly; he soon got up to $1 million in sales. But then he started wondering: How reliable are some of these people? “We had to figure out how to mitigate our worry over not getting paid in a timely manner, or at all,” Compton says.
He decided to play it safe: He told many vendors that he simply couldn’t sell to them at the time. And it went on like this for months, with Compton turning down business because he wasn’t sure when he’d get paid.
Then he discovered a solution: trade credit insurance.
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How does it work?
Trade credit insurance is also called accounts receivables insurance, and it’s like a guaranteed credit check with benefits. You can buy it from specialty insurance companies or risk-management brokerage firms. And it works like this: When you’re talking to a new customer, you can have your insurer check the customer’s creditworthiness. Within hours to a few days, you’ll learn if the customer is financially stable and how much credit they can afford. And if everything looks good, the insurer will insure the sale. That way, if the customer doesn’t pay, your losses are covered by the policy (up to a specified maximum, of course).
Coconut Beach eventually purchased a policy for $20,000 per $5 million in orders; it covers a max of $750,000 in losses. That’s an expensive premium, but it does come with a nice benefit: Claims are usually paid out in a matter of weeks, a boon to cash-starved startups that need all the incoming cash flow they can get.
Who needs it?
That’s debatable. If you want to find out if U.S.-based companies pay promptly, you have many ways to do it: credit checks, contacting other vendors and so on. But that research takes time. Do you have it to spare? There’s less debate in industries with a high percentage of bankruptcies and closures, or ones that rely heavily on international customers. If that describes you, trade credit insurance could be critically valuable. To find a policy, contact your business insurance broker. Euler Hermes, Coface, AIG and Marsh are a few of the main players writing policies.
What’s the risk?
Euler Hermes, an insurer that offers trade credit policies for small companies with $1 million to $5 million in revenues, estimates that one in every 10 invoices is delinquent. Can your business afford to write off 10 percent of its accounts receivables?
So, was it worth it for Coconut Beach?
“I wish we had had trade credit insurance during the first five months we were in business,” says Compton. “We said no to a bunch of potential domestic customers because we didn’t know anything about them.” Compton simply didn’t have time or the manpower to conduct credit checks on every new customer -- he was too busy managing his business. But now, with his insurance policy in place, he is able to say yes a lot more often. It’s as simple as contacting his insurer: “A phone call and a couple of follow-up emails,” he says, “and I’m done.”