Equipment financing in an uncertain environment
Do you know how to finance equipment in an uncertain market?
2017 is proving to be a new era for U.S. industries. The overall economy is improving, demand from customers is growing, and just about every industry is feeling the effect — directly or indirectly — of regulatory moves in Washington.
In this environment, companies face a balancing act if they want to grow. Capital expenditures for new equipment can support expansion, but minimizing financial risk is imperative. Both risk and potential growth vary across industries. Construction, for instance, is seeing moderate growth in most subsectors, from single-family housing to public works. The sustained growth that marine has enjoyed for six years will likely continue. And healthcare shows several areas of opportunity — including value-based care initiatives and digital consumer engagement — despite the uncertain future of insurance markets.
Yet other industries have cloudy crystal balls. Majorities in the House and Senate have plans to cut taxes and roll back regulations that have potential to benefit manufacturers, but uncertainty regarding foreign trade initiatives could have adverse effects. The aircraft industry, with its long lead times, faces a mixed bag, given its reliance on exports and the effect of Brexit on Europe.
Acquiring the equipment needed for growth, then, can be a complex investment decision. The optimal financing structure for a business depends on its goals, the assets required for technical advantage in its industry and the company’s financial position. The information in this article is designed to help answer your questions so you can make the most informed decision.
Equipment Finance Options
With tax leases, the lessor maintains ownership from a tax perspective. Through the lessor’s tax ownership and retention of depreciation benefits, your firm receives the advantage of lower payments and maintains liquidity and availability of capital. Your business also has greater asset flexibility by deferring the purchasing decision:
- Fair Market Value Lease: The lessor provides 100 percent of the funds required to purchase equipment for lease over a defined term. These leases are generally “true leases” for tax purposes (i.e., the lessor is considered the owner and takes MACRS allowance deductions related to the equipment). These leases provide your company with maximum asset flexibility, enabling you to decide whether to return or purchase the equipment, or renew the lease at the end of term. These leases can also be structured with fixed early buyout options during the term.
- Terminal Rent Adjustment Clause Lease: A TRAC lease is for use with titled, over-the-road motor vehicles and provides the benefits of a True Lease, while giving your company the option to purchase the equipment for a fixed amount at the lease end. If you decide you don’t want the equipment, it can be sold to a third party and, if the proceeds exceed the fixed purchase option amount, your company retains the excess.
Non-Tax Leases and Loans
These financing vehicles typically permit advance rates up to 100% of cost and enable your company to retain the benefits associated with owning equipment:
- Secured Loan: The asset your business acquires is pledged as collateral for the loan. This works best if you need to own your equipment long-term and want to retain the tax benefits of ownership.
- Finance Lease: Your business selects the asset and has rights to use it, while the lessor purchases it. Your company has the option to acquire ownership at a later date. Your business can expense all interest paid and depreciate the equipment cost over its life.
- Synthetic Lease: This is a finance lease, which may qualify as an operating lease for your company’s financial reporting purposes. It also permits your company to utilize the Modified Accelerated Cost Recovery System’s (MACRS) allowance deductions as if the transaction were a loan. This type of transaction is fundamentally equivalent to a partially amortizing term loan with a balloon payment, some or all of which is satisfied by relying on equipment value, with the lessor retaining some at-risk position in the equipment.
Equipment Finance FAQs
How do I decide between a tax and non-tax lease?
Generally speaking, if your company is an ESOP, has foreign tax credits or is not a full taxpayer—whether that means you have existing net operating losses or you are in an alternative minimum tax position—a tax lease may be the best fit. That is because the lessor will pass tax benefits through to you as lessee by offering a lower lease rate. A lease may allocate tax benefits to the most tax-efficient party.
My company is considering alternatives for raising capital or diversifying our funding sources to manage our fixed and floating rate debt mix. What are some of the benefits of leasing over purchasing?
Many companies appreciate the flexibility that comes with leasing – both in amortization structure and in payment terms. The benefits for cash management are also often a factor; you can put your cash to better use for R&D, sales programs, inventory or other projects. And there is simplicity —the leased equipment is typically the only collateral required to secure the transaction and there usually are no covenants. A lease also provides 100% financing. Equipment leasing can limit your asset risk in multiple areas:
- Avoiding technology obsolescence — you can stay current by returning equipment to the lessor at the end of the lease
- Letting the experts handle the sale of used equipment — the lessor can take care of that for you
- Tying lease terms to a specific business contract
- Deferring decisions — if you need equipment today, but are unsure that long-term ownership makes sense, you can wait until the end of the lease to decide
Can a lease line of credit be established before a lease application?
Lease lines of credit are common and can be approved for up to a 12-month period. Within the lease line, different structures may be used for different types of equipment depending on your needs. Progress payments or interim funding for projects requiring construction may also be available.
What types of equipment can be leased?
Typical leased equipment categories include construction equipment, trucks, tractors and trailers, railcars, corporate aircraft and helicopters, marine, manufacturing, distribution and warehousing equipment, material handling equipment, general industrial, technology/IT and medical equipment. Typically, third-party owned software or assets classified as fixtures such as building improvements – would not be leased. The structure of leases and the economics for each category will likely differ. Lease structures will also be driven by your needs.
What is a sale-leaseback? Can it help my business?
A sale-leaseback is a finance tool that allows you to sell equipment you own— free of debt — to an equipment finance company, then lease it back for your use. Companies using sale-leaseback arrangements often do so to monetize assets they own in order to reimburse themselves for purchases made before making the decision to lease or finance it, pay down debt, expand their business or fund an acquisition.
How far in advance should my company start exploring our equipment finance options?
To make sure you have plenty of time to weigh the benefits of various finance options, you should begin research at least one quarter before the date you plan to acquire your new equipment. Some companies do lease planning as far as a year out and as part of their overall strategic plan.
What will the equipment finance company look for in terms of financials and other information from my company to get the lease process started?
Typically you will need to provide the equipment finance company with:
- Three years of annual financial statements and current interim statements (with comparable statements for the same period in the previous year)
- For closely held or Subchapter S corporations, owners’ financial statements may be required
- Copies of invoices, purchase orders, contracts and other relevant information applicable to the equipment your company is acquiring
- Company brochures, investor presentations (if applicable), organization structure or any other information that may help the equipment finance company better understand your business
- Listing of senior management, with biographies
What are my options at the end of a lease?
Your options depend on the lease type you choose to match your financing needs and may include: fixed or fair market value purchase options; renewing the lease for a mutually agreeable term; or returning the equipment to the lessor. These options may be modified, depending on your specific needs and may include fixed early buyout options. For non-tax leases, you can either arrange a fully amortized structure or negotiate a fixed balloon payment, which provides a longer amortization period.
What if I want to buy the equipment before the lease ends?
Certain lease products may include an early buyout option. This type of lease allows you to buy the equipment at a predetermined price and at a specific time before the end of the lease. Taking advantage of this option lets you buy the equipment when your company has available capital and avoids future rental payments and uncertainty as to the future value of the equipment.
It’s important to stay competitive in a growth market and an expanding economy. When you have questions or are making decisions about financing your equipment needs and want to understand all your options, talk with a professional who can guide you.