Understanding deposits and collateral

One of the biggest problems facing busy shops is the need to increase capacity while maintaining the same number of operators because of how tough it is to find—and keep—good people.

One option is installing new technology that performs more operations on the same machine, which reduces setup time. Another is automating the process entirely.

After deciding on your path, the next issue then becomes securing funding, which can be challenging for one simple reason: These are expensive assets and the funds necessary to purchase them are not normally just sitting in your bank account.

Now still taking COVID-19 into account, 2020 and 2021 may have been busy years, but they may not have been very profitable, all things considered. This means that the results of your last three financial statements could make it tough for you to attract a lender. However, one option that will help you secure funding, particularly in cases where the transaction size (equipment cost) does not match your credit profile, is to provide additional collateral.

Providing additional collateral can facilitate a lease approval which otherwise may be unattainable. Here are three approaches:

1. Add a Deposit

If you aren’t approved for 100 per cent of the equipment’s value, offering a deposit has two positive effects. First, it shows that you are serious about adding this necessary equipment because you are using a portion of your own funds.

Second, from the lender’s standpoint, a deposit also mitigates the risk of the transaction.

If you are working with an alternative lender, typically a leasing company with manufacturing industry experience, the quality of the asset and its perceived resale value factors into the application process in the event of a default.

If a sizeable deposit is made, the lender knows that even if the deal goes sideways and the equipment is reprocessed, a significant amount of funds will be recovered once it is resold.

The truth is, once a borrower is a few years into the lease of a quality machine tool, especially if a large deposit has been made, the lender is most likely in an equity position, meaning the machine is worth more than the payments owed. This is what allows leasing companies to approve transactions that a typical bank will reject.

2. Use Existing Equipment

Even though cash is king, pulling a deposit from working capital can be problematic.

When business is slow, cash can be tight, and shops need it for labour costs, material, and tooling. It also can be months between a production run and the collecting of receivables. However, there usually is “money” sitting on the shop floor that can be used to help purchase new equipment.

A brand-name used machine tool in good condition is an asset that holds its value over a long period of time and can be used as collateral. You only need to ensure that the asset’s title can be conveyed to your lender so it can use it as collateral.

To use existing equipment as collateral, your bank must provide a waiver—a simple document that waives its interest in a specific piece of equipment so another lender can use it as collateral.

3. Use Home Equity

It’s a common practice for manufacturers to set up their financial statements to show limited profitability to minimize tax implications. However, it usually has very little relation to actual net worth.

In most cases, it is the complete opposite. Successful manufacturers normally have extremely strong personal credit profiles and own not only their own homes, but commercial properties as well.

These individuals have plenty of equity available in their properties, so finding money for a deposit could be just as simple as pulling funds from a home equity line.

Another option, particularly when working with a leasing company that is familiar with the manufacturing industry, is allowing the leasing company to put a collateral charge on a property, which has ample equity to cover the transaction.

This essentially is a registration with the land title or registry office in the municipality. The charge sits in first or second position—behind the mortgage—and provides the required collateral. The leasing company then arranges for an approval of 100 per cent of the transaction, meaning no deposit is required.

The advantage of using the charge, beyond the obvious of not having to pull deposit money from working capital (or trying to convince the bank to provide a waiver) is it can be discharged at some point long before the lease ends.

The time frame could be a little as a few years when both a payment history has been established and the financial statements are showing increased growth and profitability.

Adding manufacturing equipment to your shop is not a cheap or simple endeavour. These are big-ticket items that require time and effort to both source and fund. It’s therefore very important to understand there are options that will attract lenders and it usually starts with making the best use of your existing assets.

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