On Wednesday, FreightWaves reported that Convoy was ceasing operations. Earlier in the morning I had started writing an article about cash flow problems that some freight brokers are having or will have. Then it was announced that one of the best-known freight brokers to emerge from the venture era of freight technology financing would fail that same morning.
Convoy was a victim of a violent mass industry facing one of the worst recessions in decades and a sudden shift in investor appetite from risk to unit economics.
While many articles will be written about Convoy in the coming weeks, unfortunately it will not be the only major broker to suddenly cease operations.
That’s unusual.
After all, anyone who has ever worked in the freight forwarding business knows that asset-based carriers often face the threat of failure. However, it is rare for freight brokers to suddenly close. Compared to truck fleets, freight brokers have significantly greater flexibility in their business model to adapt to changing market conditions
But we will see many more large freight brokers suddenly close. And the reason is a significant change in the financing climate.
In an article earlier this week, I wrote about the growth and expansion of the freight brokerage industry over the last decade. Freight brokers have grown from a small cottage industry to a major force in the freight industry. A large part of FreightWaves’ success is due to the increasing importance that freight brokers play in the industry.
After all, freight brokers are the day traders of the freight market and therefore need up-to-date information about the freight market.
FreightWaves was founded at a time when freight brokerage was evolving from a small part of the industry to a dominant force. FreightWaves owes much of our success to this reality.
However, much of the brokerage industry’s growth has been driven by financing structures such as venture capital (VC) and asset-based lines of credit. Freight brokers’ appetite for venture financing has been waning for over a year and is partly to blame for Convoy’s failure. VC investors have recognized that freight brokerage is not risk investing.
For those brokers who did not use VC funding but financed their growth through alternative lenders, the situation is different, but the results are the same. These alternative lenders are common throughout the freight market. Freight forwarding companies use factoring companies to finance their receivables in a transaction-oriented manner. Brokers do the same thing; However, this is often not done per transaction, but rather on the basis of a portfolio of receivables.
(Photo: Jim Allen/FreightWaves)
Accounts receivable are pledged as security for lines of credit called an “asset-based line of credit,” or ABL. This allows a brokerage firm to grow quickly without having to wait for shippers to pay.
When the market and unit economy expands, it is a very efficient way to grow. For traders in the stock market, it can be compared to using margin to buy stocks.
If the value of a stock position increases, you will receive a larger line of credit. The danger, of course, is that you use the line of credit to buy more shares of the same stock. If this stock collapses, you’re in real trouble as your losses will only compound on the downside.
The same thing happens in the brokerage sector. Freight brokers have been borrowing against their AR portfolios to fuel growth and accumulating debt on favorable terms. When the Fed changed the cost of capital, this debt became more expensive. That in itself is not the problem.
But something else happened to the truck market.
The average transaction size of loads also plummeted. Loads that generated $3,000 in revenue two years ago are now shipping for just $1,500 in revenue. If you do too many of these transactions, the credit facility will begin to collapse.
This isn’t necessarily a problem if the brokers had kept the capital during good times. However, it becomes a problem when this capital is used for more growth or other purchases. For Convoy, it should spur growth. For other brokers, it could be for personal purposes such as houses, cars, planes, yachts, etc.
The capital has now been spent, but the debt is still there. And financial firms, aware of the risks of freight volatility, sought to protect themselves by including covenants in these credit lines, often measured against margins.
As margins shrank, covenants were breached and financiers became nervous. Now some of them are faced with a dilemma: continue to finance the credit line or take advantage of it. In Convoy’s case, the credit line appears to have been drawn down.
In recent weeks, FreightWaves has heard from sources that a number of mid-sized freight brokers are experiencing financial difficulties. A CEO of a large brokerage who discussed potential deals told me that the risk was greatest for brokers generating $50 million to $250 million in revenue.
A CEO of a major trucking-focused bank told me that he had three large brokerage firms in his portfolio that were in dire financial straits and that he expected them to close in the coming months.
These companies have used accounts receivable financing to fuel their growth. However, due to the collapse of market fundamentals, they violated their agreements.
The banks that financed these asset-based loans have tried to hook up some of these brokers, but their patience is starting to wear thin.
Unfortunately, things will get worse.
The most brutal part of the cycle for a freight broker is not a soft market.
This is when the freight market begins to recover and spot rates improve, while contract rates remain under pressure. This reduces brokerage margins.
In other words: the spread between spot and contract narrows. When that happens, it hurts the acceptance rate for freight brokers.
A large percentage of contract rates are locked in during offer season. If conditions are soft at the time of bidding, contract rates will decrease.
Bidding season traditionally begins in mid-October and ends in February. Freight rates have been very low throughout the year and there was no improvement at the start of the offering season.
Due to excess capacity in the market, both spot and contract rates have remained low – on some routes as low as or lower than in 2019. These conditions will place significant strain on contract rates during the 2023-2024 offering season. We expect contract rates to continue to fall as carriers realize they are “lower for the longer term.”
Spot fares are currently at a level where airlines are losing money on many of the miles they travel, and are unlikely to fall any further.
This will reduce brokers’ margins, exacerbating any financial difficulties experienced by brokers.
Therefore, I expect we will see some hectic deals in the freight brokerage business in the next few months as healthier players eliminate the weaker ones.
I also expect bankruptcies for those companies that are under significant financial strain. Bankruptcies are common in the trucking business, but it is typically asset-based trucking companies that go under.
This cycle could be the first time a series of bankruptcies impact the brokerage market.
7th–9th NOVEMBER 2023 • CHATTANOOGA, TN • PERSONAL EVENT
The second annual F3: Future of Freight Festival will take place this November in Chattanooga, the “Scenic City.” F3 combines innovation and entertainment with live demos, industry experts discussing freight market trends for 2024, afternoon networking events, and Grammy Award-winning musicians performing in the evenings in cool Appalachian fall weather.