Three key questions about the benefits of leasing capital equipment

Using a lease when adding capital equipment frees working capital for short-term expenses like tooling and labour.

Despite all the unanticipated challenges presented to the manufacturing industry in the last few years, including the rising cost of borrowing, it has, for the most part, been on a long run of both prosperity and growth.

This means manufacturers have had a constant need to upgrade equipment. Since I always seem to have the same conversation with many potential clients at the start of the year, I thought this would be a good time to share a few of my most frequently asked questions.

1. Why isn’t my bank interested in my business?

Buying the latest technology is a very expensive proposition, particularly when the cost of borrowing has increased significantly in a relatively short period of time. Despite the fact that good equipment, when maintained properly, will run in a shop for more than a decade, it is a difficult transaction for a typical banker to understand.

I have worked with several underwriters who came from the banking world and gained some insight into how they review applications and assets. Essentially, they look at every asset, regardless of what it is, and assume that if the deal goes sideways, they will recover about 20 per cent of the asset’s value. This means the borrower is adjudicated based on a risk of 80 per cent of the transaction value and approved or declined accordingly.

2. Why is a lease a good idea in these cases?

When a leasing company with expertise in equipment financing looks at that same transaction, it knows the recovery value for a machine tool is a much higher percentage and it can approve more transactions solely because the perceived risk is significantly smaller.

A leasing company is not looking to be anyone’s banker, however. It is a complement to what is already in place. My most successful customers all have well-established banking relationships with large operating lines, which they properly use for short-term debt, like financing receivables or for covering operational costs like buying tooling and material.

They use equipment leasing to keep from tying up bank lines or working capital for long-term needs like machinery and equipment.

What this allows these owners to do is reinvest in their business where the return is much higher.

One example of where cash can be put to its best use is product development, something that cannot be financed, but where the return can be enormous. One of my most successful clients is a leading innovator in the medical industry that leases all of their equipment and reinvests profits back into the business to develop new products.

Another customer of mine has a passion for owning property. They operate the manufacturing business from several different plants, all of which they own, and their success has allowed them to invest in other unrelated properties.

Another good use of cash is hiring a salesperson. Small to medium-sized shops often have owner/operators that run the plant to ensure that good parts are made and delivered in a timely matter, but they also handle all of the quoting and estimating. They function as both the sales manager and plant manager, two roles that are best suited for two different individuals.

3. Why aren’t your rates identical to those at my bank?

When a bank reviews a lease application, it always evaluates its exit strategy first. A leasing company that is staffed with individuals familiar with both the manufacturing industry and equipment knows there is more to it than just asset value.

This means a $100,000 machine tool transaction isn’t a risk of $100,000, because if the deal goes bad in the first year when the fewest payments have been made and the equipment is repossessed, 50 to 60 per cent of the original value will be recovered when the equipment is re-sold.

A leasing company looks at the risk in the transaction as being only the difference between the original selling price and the recovered amount when re-sold. This is a much broader range, so more borrowers are approved. However, it is important to note that a new piece of equipment depreciates from the moment it is installed. Because the equipment itself is the collateral for the lease, a typical leasing company doesn’t have nearly the amount of security as a bank.

Because it is a riskier transaction for the leasing company than for the bank, the leasing company charges slightly more.

Over the last five years, bond rates have been stable while the prime rate, the basis for all bank lending, sat at historic lows. The impact of these low rates led to the inflationary market of 2022 and 2023, so it was just a matter of time before the Bank of Canada raised lending rates.

It is hard to tell what 2024 will look like, but inflation numbers dropped last fall, which means the rate increases had their desired effect and should foster some stability going forward.

If there is one take away here, it is that there are financing options beyond that of a bank which, if properly sourced, are good complement to any borrowing that is already in place and provide some additional flexibility.

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