Raise cash by using a sale leaseback

There is no doubt that one of the biggest struggles for any business is managing cash flow, and the manufacturing industry is no different. Even if the market isn’t slow, maintaining enough funds to cover monthly overhead costs can be challenging to say the least.

There is no question that given the choice of an outright purchase or entering a lease or loan transaction, it is much more palatable for any manufacturer (or individual for that matter) to avoid the cost of borrowing.

However, when shops are busy, the cost of labour, tooling, and materials are incurred upfront and payment for the manufactured product typically is 60 to 90 days (or more) after delivery. In other cases, there could be a delay in landing an order from a good customer because of reasons beyond anyone’s control, with COVID-19 being a textbook example.

Keeping staff and materials available while in a holding pattern also applies pressure on cash flow. One way to solve these dilemmas is to arrange a sale leaseback with a lender that understands the value of your equipment and the manufacturing industry.

What Is a Sale Leaseback?

A sale leaseback is a transaction that conveys ownership of existing equipment--at an agreed upon price--to a financial institution in exchange for a lump sum cash payment.

The manufacturer then leases the machine on a long-term basis while retaining exclusive possession, and, ultimately, takes back ownership once the transaction has been paid in full.

This type of financing works extremely well for good brand-named machine tools because, when maintained properly, they hold significant value for a very long time.

As an example, I have a customer who leased a new $250,000 vertical machining centre over a five-year term. The original lease was paid in full, and they took ownership of the machine. Since the time of the original lease, I have on two separate occasions raised money using that same machine when they required working capital.

The point is that even older machine tools still maintain enough value that a lender with experience within the industry will release funds using its value.

Understanding Value

Several factors affect how much money can be raised using a piece of equipment.

First, lenders require an appraisal from a member of a professional organization like the Association of Machinery and Equipment Appraisers (AMEA). The AMEA, of which I am a member, is the premier international organization for certified equipment appraisers, many of whom specialize in appraising machine tools.

The appraiser considers three factors while assessing the value of a piece of equipment.

1. Manufacturer

Many different machinery and equipment builders exist, all of which have their place in the market. However, high-end equipment built by Japanese, Taiwanese, Korean, and European machine tool builders hold their value because these machines are known to hold tolerances and have a long, useful lifespans when properly maintained.

These companies also have large installation bases and well-established sales representation, either directly or by a distribution network that supplies application, service, and spare parts support.

2. Use

How the machine is being used is an important factor because it can be used to manufacture a variety of different parts across a broad number of industries, and there are plenty of differences between manufacturing environments.

Two identical machines can have vastly different values depending on how they are used.

A machine tool in your average manufacturing environment that runs for one shift and is used for approximately 2,000 hours per year would hold a different value than an identical machine that is being used in the automotive industry, which is known to run machines much harder and for multiple shifts per day.

3. Condition

In the world of machine tools, condition is dependent upon proper maintenance. The amount of maintenance a machine tool requires is related to its usage and even the type of material it has been cutting.

A piece of equipment that has been cutting aluminum, an easy material to cut, typically will be in better condition (and therefore worth more) than an identical machine that has been cutting cast iron, which is a very abrasive material that produces chips known to cause long-term damage to a machine.

It’s important to note that you must own the machine that you want to use for sale leaseback and have no outstanding debts or balances owed. Because the asset itself is the collateral for the sale leaseback, it is of utmost importance to ensure that the full title of the asset can be conveyed to the lender.

So, it sounds simple: You buy a machine tool, pay for it, and therefore, you own it and can borrow against it. But a general security agreement (GSA) from your bank may stop you from doing this.

A GSA provides the bank with a security interest in your inventory, accounts receivable, equipment, and other assets. Every piece of equipment purchased, even if it was paid for in cash, automatically is included in the GSA, giving your bank the first rights to the asset.

The sale leaseback can still proceed if the bank provides a waiver that relinquishes its interest in the specific equipment that is being used to raise the funds. This is a normal request that banks see often.

A manufacturer’s biggest pain point often is managing cash flow. Therefore, knowing all the different places where capital can be accessed is extremely important. It can be just as simple as accessing money that already has been spent.

Ken Hurwitz is vice-president of Equilease Corp., 416-499-2449, ken@equilease.com, www.equilease.com.