Dealing With Downturns

A question I quite often get asked is What are my options if -- for whatever reason -- the equipment on my floor is no longer required, but there is still an outstanding loan or lease that has to be paid?

There is no doubt it has been a tough market for a number of industries in Canada recently. The oil sector still has not seen any signs of relief for almost two years and, without question, manufacturers have surplus equipment on their floor, at least for the moment.

The obvious answer would be to put the equipment up for sale in the hopes of finding a buyer that will pay enough to cover the outstanding debt. Depending on the equipment, whether there is an active market for that particular piece, and how far into the loan or lease the manufacturer finds itself, this could be the path of least resistance.

Holding Value

When it comes to lending, machine tools are one of the best assets to finance because a good, brand-named piece of equipment that has been properly maintained and still holding tolerances will certainly hold its value. Even in cases in which the manufacturer is still in the early stages of the transaction, for example the first year of a five-year loan or lease, the equipment will hold its value extremely well. Finding a potential buyer, be it an end user or a dealer, can be done with relative ease and likely at only a minimal loss.

That said, selling and cutting losses, even small ones, may not be the best course of action because there are other options to consider.

First, it is quite common for equipment to no longer be required when the work it was originally purchased to handle has changed. This could simply mean the part had a design change and some additional features were added, and in order to produce these “new” parts, another machine tool style or model would prove more efficient and profitable.

In a case such as this, I recommend the customer look at trading up the machine, which basically means source the new machine and trade in the current one against the purchase of a new replacement.

I recently had a customer that was halfway through a $175,000 lease, so essentially they still owed another $87,500. In this particular case, the parts they were producing had become larger and they required a different machine with a larger capacity. The shop owner sourced a new machine for $210,000, and the dealer that sold him the original machine offered a $75,000 credit for the used machine.

For us as the leasing agent, it was a simple transaction. We added the cost of the new machine to what the customer owed on the current machine and then subtracted the credit ($210,000 + $87,500 - $75,000) and got him approved for $222,500.  Since my customer was now going to start a new five-year lease, the fact that they did not get dollar for dollar on the trade didn’t make that much difference because the overall monthly payment changed only by a nominal amount, approximately $250 per month.

However the customer was getting more money per part for the larger work, which ended up providing a larger surplus of revenue on a monthly basis, despite the fact the lease payment increased.

Other Options

There is at least one other option that may be more advantageous than the straight sale of a machine that no longer is generating income.

Once again this will work for a good, brand-named machine tool that holds its value. If the machine is in the latter stages of the loan, or if the equipment is owned outright, then a leasing company with a background in understanding equipment value can then rewrite the lease, or arrange for a sale/leaseback, and front the owner some equity from the machine.

As an example, one of my customers had leased a $150,000 vertical machining centre and was about 3.5 years into a five-year lease, meaning they still owed roughly $53,000.

The manufacturer was slow because one of its very good customers had closed. And even though it had quoted enough new work and were confident some of it would eventually become orders, it needed money to cover the lost revenue, without parting with any of its equipment.

Since the machine was now worth more than what was owed, we raised $35,000 in working capital against the machine and started a new lease over five years for $88,000. The new lease worked out to be about $1,200 less per month because the transaction was now significantly smaller than it was originally.

Along with the additional cash, it bought the company plenty of time to secure the new work while keeping a machine it never wanted to sell in the first place.

We actually have customers who have leased equipment, paid it off, and then subsequently raised money against the same piece, and in some cases more than once.  Other than property, I cannot think of any other asset that can hold its value long enough to be used as collateral for a lease on more than one occasion.

Since I have been working in the manufacturing industry, I have had a front-row seat for some of the best and worst markets during the last 2.5 decades. The only insight I can provide without question is that it’s almost impossible to predict what is going to happen next.

Therefore, knowing you have options when times get tough can be the difference between making it through and having to cut your losses.

Ken Hurwitz is senior account manager, Blue Chip Leasing Corp., 416-614-5878, www.bluechipleasing.com.