Summary
- Distribution companies face three primary financial risks: supply chain disruptions (preventing fulfilment of contractual obligations), contractual disputes (arising from damaged or non-conforming goods), and market volatility (where price changes between contract formation and delivery can result in losses).
- Businesses can mitigate these risks through four key strategies: incorporating as a limited liability company or LLP to separate personal and business assets, negotiating favourable contract terms including force majeure clauses and liability limitations, obtaining comprehensive insurance, and using financial instruments such as hedging and factoring.
- A thorough business plan addressing market focus, product range, operational model, and inventory management, combined with careful financial forecasting of upfront costs, cash generation, and credit requirements, is essential before launching a distribution business.
- This article is a guide to starting a distribution company for entrepreneurs and business owners in the UK, explaining the key commercial and legal considerations including risk management, incorporation, contract negotiation, and insurance.
- LegalVision is a commercial law firm that specialises in advising clients on business structures, commercial contracts, and startup matters.
Tips for Businesses
Incorporate your distribution business as a limited liability entity before entering into significant contracts to protect your personal assets from business liabilities. Engage a commercial solicitor to review and draft all supplier and customer contracts, ensuring force majeure clauses, liability limitations, and price-fixing provisions are included to allocate risk appropriately. Consult an insurance broker experienced in distribution businesses to obtain tailored coverage for goods damage, financial loss, personal injury claims, and legal fees before commencing trading.
Distribution companies are essential to the supply chain because they supply goods from manufacturers to retailers or consumers. Furthermore, issues with the supply chain can cause a wide range of effects on the market. Therefore, if you wish to start a distribution company, there are some critical things you must first consider. This article will explore the key commercial and legal considerations you may want to evaluate when creating a distribution company.
Business Plan
Like most businesses, your distribution business will certainly benefit from a good business plan. This plan should address your:
- market, such as whether you will operate as a retail distributor or a wholesaler;
- products, such as will you focus on a specific product, like a particular drinks brand, or will your focus be broader, such as the food and beverage market;
- operations, such as operating on a brokerage, import/export, cash-and-carry, or online sales distribution basis; and
- inventory management, including whether you will warehouse goods or operate on a just-in-time model.
Financial Plan
Distribution businesses can be quite capital-intensive. Therefore, you will likely require a combination of cash and credit to facilitate your business’ purchase and sale needs. Moreover, you will need to consider your financial plan carefully.
Before you set your business in motion, you should be able to forecast:
- upfront costs;
- cash generation;
- credit requirements; and
- financing arrangements.
Understanding Your Risk Profile
Risks can come in different forms, such as health and safety risks. Although, some businesses are riskier than others. The primary risk distribution companies face is financial risk, which primarily arises in three ways.
Supply Chain Disruptions
This is where you run into issues when taking hold of the goods or delivering them to your customer. One way this can happen is due to logistics issues. For instance, if your supplier’s warehouse catches on fire or a pandemic forces the world into lockdown. Additionally, someone in the supply chain may no longer be able to access trade credit and cannot fulfil their end of the supply contract.
Primarily, when there is a supply chain disruption, you risk not being able to fulfil your end of the contract. For instance, consider that your leading supplier runs into credit issues, and their creditors exercise certain protections locking down their inventory. This might prevent you from obtaining the goods.
Contractual Disputes
These disputes may arise when you and a supplier or customer disagree over the terms of your contract. For instance, a dispute may arise if you deliver goods not up to your customer’s specifications because they suffer some damage during transportation.
Market Volatility
A lot can change between when you enter into a distribution contract and when you have to deliver on your obligations. Notably, the prices of goods may be subject to change. Therefore, distribution companies often rely on agreements made well before the delivery of goods and resultant payment.
For instance, say you distribute widgets, operating on a warehousing model. You agree with your supplier three months in advance that you will make the payment when you have the goods. However, you agree to the price upfront. Before taking ownership of the goods, the market price of the widgets goes down dramatically. You have not negotiated any sales in the interim period, which means that if you sell the widgets at market price, you will take a loss.
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Mitigating Your Risk
Because distribution companies have so many moving parts, there are many points along the supply chain where something can go wrong. Even if you are not at fault for the actual cause of the issue (for example, a fire in the warehouse), you can still be liable if you cannot uphold your obligations.
There are four ways you can mitigate your risks, including:
- incorporating your new business to obtain limited liability;
- negotiating sufficiently advantageous contracts;
- obtaining comprehensive insurance; and
- making use of trade finance tools like hedging and factoring.
Incorporation and Limited Liability
Incorporating your business into a limited liability entity will allow you to separate your business’ assets and liabilities from your personal assets. In this case, your business may be a company or limited liability partnership (LLP).
Moreover, your business’ assets are the most at stake. If something goes wrong and a company sues you for £1m, your creditors can only recover their claim from your business. Essentially, they cannot come after your assets.
However, the downside is that you will have more responsibilities. Although, this is likely to be worth it, given that distribution companies enter into numerous contracts.
Contract Negotiations
Distribution businesses primarily run on contracts as this business often involves entering into contracts with your suppliers and customers. However, contracts allocate risk, and who assumes the risk depends on the contract itself.
The ability to draft favourable terms will largely depend on the negotiating position of both parties. Frequently, parties will agree to terms without understanding their implications.
For instance, you can incorporate terms in your contract that:
- allocates risk in the event of a warehouse fire or pandemic (force majeure clauses);
- limit your liability in the event your negligence results in another’s economic loss;
- fix the price of goods depending on certain circumstances; and
- require your counterparty to obtain specific insurance policies.
Therefore, you should consider having a commercial solicitor review and draft your distribution business’ contracts to maximise your position.
Insurance Policies
Insurance for distribution businesses is quite complex. An insurance broker can help you find the right policy tailored to your distribution company’s needs. However, you generally want a policy that will protect you from:
- damage to goods in your possession;
- financial loss your business causes another;
- claims arising from personal injury; and
- legal fees.
Financial Instruments
If you deal in large quantities of goods or goods prone to price volatility, you can obtain hedging instruments to protect you from adverse movements in price. Hedging is where you agree with a third party to purchase goods at a specific price. If the price moves up, you are protected. Alternatively, the third-party pockets the difference if the price moves down.
Alternatively, factoring is where a third party “buys” a debt from you. They often pay you a portion of this amount upfront and then collect the amount owed directly from your customer. Market customs may allow the buyer to pay you after delivering the goods, depending on the goods you distribute. If they have issues making payments, this can create liquidity issues for you.
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Key Takeaways
Unlike other new businesses, a distribution company operates with a high degree of uncertainty as several people are in the supply chain. Unfortunately, this increases the chance of something going wrong. If you start a distribution business, you should have a business plan. It would help if you also considered how best to mitigate your risk through:
- incorporation;
- contractual negotiations;
- financial products; and
- insurance.
If you need help with your start-up business, LegalVision provides ongoing legal support for all businesses through our fixed-fee legal membership. Our startup lawyers help businesses manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 0808 196 8584 or visit our membership page.
Frequently Asked Questions
What do I need to start a distribution company?
To acquire goods, you will need access to capital, such as cash or credit. Next, you will need to determine how you will deliver the goods. Finally, you must consider how and where to store the goods.
What is the main risk when running a distribution business?
The main risk is that your supply chain could face disruption somewhere along the way. This might mean you cannot complete your end of a contract, which may mean you will be financially liable for losses.
How does incorporating a distribution company protect your personal assets?
Incorporation separates your personal assets from business liabilities. If a creditor pursues a £1m claim, they can only recover from business assets and cannot pursue your personal assets.
What contract terms should distribution companies negotiate to manage risk?
Include force majeure clauses for warehouse fires or pandemics, liability limitation clauses, price-fixing provisions for volatile markets, and requirements for counterparties to obtain specific insurance policies.
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