Global spending on advertising in 2020 is forecast to exceed $700 billion. Bernard Urban investigates the complexities of lending to this space where money moves like molasses and nonbank lenders are entering the game at an increasing rate.
In 2017, Greenwich Associates published a white paper entitled “Trade Finance: A Market Eager for Disruption,” which made the case that while technology is a primary driver of disruption in the space, companies are also experimenting with alternative nonbank providers in various parts of the trade finance value chain.
Ad Age Magazine estimates total spending on global advertising in 2020 to be over $700 billion. The U.S. remains the largest single global advertising market, with $246 billion in spending. The primary source of those dollars is Fortune 1000 companies with investment-grade credit ratings.
Advertising media is an increasingly complex ecosystem and money moves though it slowly. As of 2020, approximately 7,000 ad tech companies exist in North America alone. In 2018, eMarketer reported that payment terms of 90 days were increasingly common. Further, at that time, outliers reported terms stretching beyond 120 days. According to Moody’s, most companies in their Media and Publishing Sector coverage carry debt rated speculative.
The nexus of these two dynamics — the growth of alternative nonbank providers and the slow moving cashflow through the expanding global advertising ecosystem — is the focus of this discussion.
The Inadequacies of Status Quo Strategies and Tactics
For the CFO of a private, midsize ad firm, factoring for A/R is generally a tactic of last refuge. Many CFOs prefer a line of credit secured against A/R as a strategic finance cornerstone. The two primary consideration factors are cost of capital and impact on staff workload. An A/R secured line of credit has versatile utility to cover gaps in payment terms and address other appropriate financing needs the company may face. Or will it?
An A/R secured LOC used to cover extended payment gaps of 90 days or more, will in most cases eventually be inadequate. Depending on credit worthiness, the LOC against A/R will generally carry a debt to income ratio of 25% to 40% — a rate that carries little cushion, especially if other financing needs come into play. As a reference: Diageo is known to use payment terms of 120 days. Starbucks is known for 100-day terms. Coty once famously asked for 180-day payment terms when shopping for an agency to handle its $1 billion media account.
Other considerations that come with LOC facility are lien rights and non-subordination. Covenants in the LSA will likely limit other permitted indebtedness making it necessary to refinance or consolidate the LOC with a term loan secured against IP or other equity.
Realistically, at some point that A/R secured line of credit will be inadequate and exhausted. At this point, factoring becomes the next most attractive tactic to facilitate liquidity. With a timeline of 30 days to fund — sometimes less than a week — factoring presents as a practical solution. Cost of capital related to factoring is variable, and it can rise dramatically over short periods of time. Another consideration is the fact that what brought a company to this tactic is a negative credit event — an exhausted line of credit — which will likely increase the cost of capital. And cost of capital is further driven up by long payment terms, 90-days brings exorbitant rates and invoices beyond 90 days are often classified as uncollectible, even if the obligator is Starbucks.
If factoring is treated more like a swingline loan, the cost of capital can be better managed, but that brings added human capital requirements — it just creates more work. Generally disruptive to what are usually small finance teams, factoring can include demands added to employee workload such as daily reporting. The media finance workflow usually involves the settlement of discrepancies, which can already be a time intensive process, so daily reporting is not a welcome addition.
For larger companies, commercial paper becomes a prescient option. However, it is not easy to write CP in the advertising media space. For example, prior to merging with CBS, Viacom, with $12.8 billion in revenue and a credit rating of Baa3, had no commercial paper on the street. Does this mean Viacom was a candidate for factoring? Probably not. Certainly, Viacom had access to liquidity, just likely at a higher cost than might be readily assumed.
The most currently accepted and widely used model looks like this — source the strongest terms for the largest available A/R backed LOC and when that taps out, turn to factoring and hope for the best.
Imagining Better — Alternative Facilities and Innovative Solutions
Technology has turned advertising into an always-on firehose of transactions and data — this is the new normal as advertising transforms into a real-time, data-driven industry. Billing, however only occurs once every 30 days. The value of accessing liquidity in the unbilled transactions prior to those 30 days is significant. Using the energy industry as an archetype, there is an innovative opportunity to unlock value in unbilled receivables, or accrued billing, for digital media. Lines of credit or factoring cannot effectively do this.
Recognizing that a significant portion of the $700 billion flowing through the advertising ecosystem originates at companies with investment-grade credit, such as Starbucks, Diageo and Coty, another opportunity to innovate new kinds of financing tools better suited to the needs of the players in the space exists. Factoring generally doesn’t recognize accounts receivable outside of 90-day terms, severely handicapping its utility in the space, without even considering the cost of capital.
These opportunities will ultimately be addressed by a new breed of alternative nonbank providers that can deliver this with a healthy respect for the bandwidth limitations of the staffing of the ad-tech and publishing finance teams. With this in mind, in the near future, imagine that a more useful and versatile mix of borrowing for the ad-media sector might look like this: a form of a new kind of A/R finance at a fixed rate secured against A/R, paired (if necessary) with a term-loan facility secured against IP or other equity. This represents a likely path to lowest overall cost of capital with unlimited flexibility. It’s a different way — a more strategic and less tactical way — of thinking.
For a CFO, choosing the right approach at the right time is critical. But more importantly, they must be aware of all the options at their disposal and think more than one step ahead.