Consignment can be a lucrative arrangement for jewelers, as long as both merchants and suppliers take steps to protect themselves.
Effective inventory management is vital in the challenging business environment the jewelry industry is experiencing lately. Insufficient inventory can lead to lost sales; excess inventory ties up capital and incurs finance charges when merchandise is acquired with loans.
For merchants, memos can improve inventory control and reduce expenses. Memo financing is a consignment arrangement: A merchant borrows merchandise from a supplier — a wholesaler or designer — and pays for the item only after it’s sold, or returns it without penalty if it doesn’t sell. This arrangement gives merchants access to a wider product range by allowing them to tap into wholesalers’ and designers’ stock and acquire items on short notice.
Memos also reduce up-front inventory costs and financing charges. By delaying payment for the merchandise until it’s sold, the merchant frees up capital and improves cash flow.
Suppose the amount of inventory a retail jeweler owns averages $1 million. If the jeweler borrowed funds at a 7% interest rate to cover that outlay, it creates an annual interest expense of $70,000, which could be the difference between profitability and loss for the year. While memo prices are typically high and could offset what a jeweler saves on interest, taking goods on consignment can expand the merchant’s stock without requiring additional credit.
Honesty is key
Consigning merchandise creates risks for suppliers. A dishonest merchant might refuse to return the loaned goods, and several recent cases in which the unreturned consignments were valued at over $400,000 highlight this risk. Consequently, the borrower’s honesty is a key element for a successful memo transaction. Creditworthiness is also important to ensure the borrower can pay for sold items instead of diverting the funds to other uses.
“Trust but verify” is a sound strategy for evaluating prospective borrowers’ honesty and creditworthiness. Business references can share character insights based on their dealings with a merchant. Credit checks and organizations like the Jewelers Board of Trade (JBT) and the Diamond Dealers Club can provide information on a retailer’s financial condition.
Memo financing poses additional risks to both parties. Suppliers must protect themselves against the possibility of damaged or lost goods and the prospect of a borrower’s bankruptcy, while borrowers want to avoid overly onerous repayment terms or other stipulations that could disrupt their inventory management and sales.
But these risks are manageable, according to Debra Guzov, founder of New York-based law firm Guzov, LLC, which specializes in corporate transactions and litigation. “Memo financing does not have to be riddled with risk and uncertainty,” she says. “Memos must be, and easily can be, drafted to protect the interests of both parties.”
Filing a properly completed UCC-1 financing statement to perfect the supplier’s security interest in the merchandise is essential, says Guzov. (“Perfection” is a legal term for the steps required to maintain an enforceable security interest in a property, meaning the property would be protected against other creditors’ claims.) Should a merchant file for bankruptcy, the UCC-1 form prioritizes the supplier’s claim over any other creditors’, ensuring the latter cannot use the jewelry as collateral for their own claims. Essentially, the form is a public filing declaring that the property does not belong to the retailer.
Credit checks and careful attention to the memo’s details are also necessary. “Couple the UCC-1 financing statement with a credit check and a meticulously drafted memo setting forth provisions for the attribution of risk of loss and comprehensive insurance requirements, and any risk inherent in the transaction decreases appreciably,” Guzov adds.
Although some suppliers restrict or avoid consignment practices, it’s an important financing tool for many jewelry merchants and is unlikely to become less prevalent. It is an established and enduring practice, Guzov points out: “Although there is a risk, properly drafted consignments are an effective business tool providing greater flexibility in the jewelry industry, and they will continue to be used for a long time to come.”
Minimize the risks
Memo transactions involve risk, but suppliers and merchants can reduce potential problems by being diligent about the steps involved:
- Memos between the supplier and merchant must be in writing and signed by the merchant before goods are transferred.
- Key components of the memo are specific provisions for payment, bankruptcy, loss, theft and damage (especially during transit), as well as insurance requirements.
- Suppliers must file a UCC-1 statement covering the inventory before transferring merchandise, in order to perfect a security interest in the goods.
- Both parties must have comprehensive insurance coverage and provide evidence of the insurance before the goods are transferred.
If you are in this business and use memos frequently, it is cost-effective to retain an attorney to provide your company with a template.