3 ways to attract a lender

The reality of adding manufacturing equipment to an existing shop is not a cheap or simple endeavour. Getty

Now that we are a few months into 2021, the market is starting to feel normal once again (or at least what will be the new normal) and it’s time to get back to business.

One of the biggest problems that many busy shops face is the need to increase capacity while using the same number of operators. This means installing new, expensive technology, which calls for new funding.

This is challenging for one very simple reason: These assets are very expensive, and the necessary funds needed to make a purchase normally are not just sitting in a bank account. Because growth shows up on financial statements only after it has happened, it sometimes can be tough to find a lender because it will review the financial history of a business without placing value on future profitability.

Providing additional collateral in these cases can help facilitate a lease approval, which otherwise may be unattainable.

An obvious issue coming out of 2020, even though most shops remained in operation, is that sales are flat or even have decreased from 2019. The best way to attract a lender, particularly if equipment cost does not match the applicant’s credit profile, is to provide a deposit or additional collateral.

1. Use a Deposit

When getting an approval for 100 per cent of the cost of a machine is not realistic, offering a deposit has two positive effects. First, it shows that the applicant is serious about acquiring new equipment and truly believes they will be successful because they are willing to risk their own funds.

From the lender’s standpoint, the deposit also mitigates some of the transaction’s risk by getting some upfront money. A lender that understands machinery and equipment also factors in the quality of the asset and in resale.

If a sizable deposit has been made, the lender knows that even if the deal goes bad and the equipment is repossessed, once it is resold a significant amount of funds are recovered. Once a borrower is a few years into the lease of a quality machine tool, particularly when a deposit has been made, the lender most likely is in an equity position, meaning that the machine is worth more than what is owed.

2. Use Existing Equipment as Collateral

Even though cash is king for many shops, pulling a deposit from working capital can be problematic, to say the least. When business is slow, money can be tight, but busy shops have the same problems when it comes to cash flow because they have cash-heavy costs for staffing, material, and tooling, all of which need to be paid upfront.

The time between final production and collecting receivables can make it months before funds are back in the bank account. However, what many shops don’t know is that a lot of money currently is sitting on the shop floor, which can be used to purchase equipment.

Anyone with machine tool knowledge knows that a good, brand-name used machine tool is an asset that holds its value for a long time. These machines can be used as collateral as long as the title of the asset is conveyed to a lender. This is a very important point because of the General Security Agreement (GSA) that businesses have with their bank.

A GSA is signed when an account is opened, and it gives the bank the first chance against all current and future assets of the company in the event of a default. The key word here is future, because most companies grow over time and accumulate assets. However, once a business has paid for its equipment, it becomes part of the bank’s security, regardless of how the purchase was financed.

To use existing equipment as collateral, the bank must provide a waiver, which is a simple document the bank issues to waive its interest in a specific piece of equipment so another lender can have it as collateral.

A simple strategy to handle this circumstance is setting up a separate holding company that owns assets like machinery and equipment. This is another corporate entity, with an identical ownership structure, that does not have, or need, a banking relationship. The holding company has ownership of these assets and, therefore, the ability to use them as collateral when necessary.

3. Use Home Equity as Collateral

Successful manufacturers normally have extremely strong personal credit profiles and not only own their own homes, but often other commercial properties as well.

Despite COVID-19, property values have continued to rise, so many shop owners could have plenty of equity available in their properties. Finding money for a machine deposit could be just as simple as pulling funds from a home equity line.

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

This essentially is a simple registration with the land title or registry office in the municipality.

In this situation, the lender would be in the first position, or the second position behind the mortgage provider, and provide the required collateral itself. The leasing company can then arrange for an approval of 100 per cent of the transaction and more favourable terms, because no deposit is required.

The advantage of this, beyond the obvious of not having to pull deposit money from working capital or trying to convince the bank manager to provide a waiver, is that it can be discharged at any point, even long before the lease ends.

The reality of adding manufacturing equipment to an existing shop is not a cheap or simple endeavour. These are big-ticket items and they require both time and effort to source and fund. It is therefore very important to understand the options beyond just providing cash to attract lenders, and it usually starts with making the best use of assets that already have been accumulated.

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