Finance Column: The most common question I get

As we start 2016, I thought as an opening article I would answer the most frequent question I am asked by both existing and potential clients as they try to figure out how best to finance their equipment purchases.

It's usually a variation of: “Why should I lease, isn’t leasing only for companies who cannot write a cheque?”

There is no doubt many of my customers are not bankable—meaning from a financial perspective the company can not support the transaction required to get a new piece of equipment. Buying the latest technology can be a very expensive proposition, and despite the fact good equipment, when maintained properly, will run for more than a decade (there are plants where 20-year-old machines are still running and holding tolerances) it’s still a significant cost and is difficult for typical bankers to understand.

We recently hired a new credit analyst who came from a charted bank, and I got a first hand recount of how they review assets internally. Essentially they looked at any asset, whether it was a machine tool or a trailer, and assumed if the deal went bad they would recover about 20% of the value.

Now when a leasing company, with expertise in machinery and equipment, looks at that same transaction they know the recovery is a much higher percentage and therefore are able to approve the lease because the perceived risk or exposure is much smaller.

That said, my largest and most successful customers have very well established banking relationships with large operating lines, which they primarily and properly use for short-term debt like financing receivables or to cover short-term costs like buying extra tooling and material for a large job they just landed, and they use equipment leasing as a complement to their bank.

They essentially match the lenders with their debt requirements. They stay away from tying up bank lines or working capital with long-term needs like machinery and equipment. This allows these owners to reinvest in their company where the return is much higher.

One example of where cash can be put to its best use is in product development. This is something that cannot be financed, but the return can be enormous. One of my most successful clients, a leading innovator in the medical industry, leases all of its equipment from various sources allowing it to keep profits in the company to develop new products.

Another customer of mine has a passion for owning property and the business is operated from a number of different plants, all of which are owned, and they have invested in other properties unrelated to their manufacturing business because it is an appreciating asset with a great return.

Another great use for working capital would be to hire a salesperson. Many of my most successful clients are owner operators, so not only are they running the plant, making sure good parts are being made and delivered to their best customers when promised, but also handling all the proposals (quoting/estimating). They function as both the sales manager as well as the plant manager, two roles best handled by two people.

Depending on the business it could make a lot of sense to bring someone in, or re-assign a role to a current employee, to handle sales. I can tell you from firsthand experience, business development is a full-time job but one which can potentially have a great return. Investing in your business is always the highest and best use of working capital, and it’s something which cannot be financed.

Lastly, and this is something that comes up quite often, is the flexibility which a leasing company can provide. When a new piece of equipment is purchased it usually takes time to get installed, set-up, programmed and debugged before the owner is making any money. However regardless of whether the equipment is being financed internally or a lender is involved, for the most part the equipment is paid upon delivery or with a nominal hold-back until it is installed.

What a leasing company can potentially offer is a program where the payments are deferred for a few months so the manufacturer does not make any payments until the machine is up and running and, most importantly, generating revenue.

This flexibility is also found when a customer has been approved for say 80 or 90 per cent of the transaction size, but a deposit is required.

A competent leasing company can structure a contract so this deposit is paid over the first six or 12 months of the lease as opposed to in its entirety upfront, and a new piece of equipment can find a floor that many not otherwise have been an option.

I know I’ve covered a lot of territory here, but if there is one thing to take away from my first column of 2016 it’s that finding an alternative source of funding to complement your bank will allow for more flexibility and could provide many additional options.  Till next month…

Ken Hurwitz, Senior Account Manager with Blue Chip Leasing in Toronto, has years of experience in the machine tool industry and now helps manufacturers of all kinds with their capital needs. Contact Ken at (416) 614-5878 or ken@bluechipleasing.com.