Consider ROI over interest rates in your next financing deal

Now that we are well into a busy 2022, I thought it would be a good idea to share some of the best practices I see from potential clients looking to arrange funding for a new piece of equipment. Before I get to the practices, however, I’ll explain where these conversations usually start: rate and cost of funds.

If this topic is the lead concern, I immediately know there is work to be done because this is not the right place to start. Now, as a service provider, I totally understand that the lowest cost of funding is important to a borrower. If I’m shopping for something, I do the same thing in cases where all things are equal, but most manufacturers are well aware that cases are rarely equal. For example, quoting a job to be the cheapest won’t always land the purchase order.

Since my business is based on 100 per cent referrals (or repeat clients), all new potential clients were given my contact information from an equipment seller or someone who has done business with me in the past.

Quite often these potential clients have previous borrowing experience only when getting a mortgage or buying a car. That’s when it’s a good idea to explain the differences between the types of lending.

Whether you are talking to your banker or a leasing company, rates are predicated on the same two things: transaction size and credit profile of the applicant.

Now let me take you behind the curtain a bit. A bank always provides the cheapest cost of funds. There are several reasons for this, but in the simplest terms, it’s because banks also have a very low cost of funds. Whatever they pay on deposits is literally next to nothing, and on top of that, their transactions are highly secured so there is very little if any risk of loss.

In the case of a property mortgage, the bank already is in an equity position from day 1 because the amount loaned always is less than the value of the asset. Most banks will not lend more than 70 to 75 per cent of the purchase price, and it’s at very cheap rates, like 2 or 3 per cent. The reasoning is quite simple. First, a mortgage is a very long-term transaction, usually 20 years or more. Because the interest is compounded--even at very low rates—the bank realizes a substantial profit.

When it comes to a car lease, the bank offers even cheaper lease rates--under 2 per cent--because the rate is subsidized by the car manufacturer.

I immediately know that I am talking to a forward-thinking client when the discussion starts with a question about monthly payment and term instead of rates and cost of funds.

If you are going to lease an asset, take the interest rate out of the conversation and evaluate the transaction based on the monthly lease expense versus potential revenue. In other words, can the current work in your shop or a newly landed contract generate enough income to justify adding a new machine to the shop floor? The reality is, if the lease payment is a small percentage of the monthly revenue, then adding new equipment is a no-brainer.

For example, leasing a $200,000 machine tool costs approximately $3,950 per month over five years but should generate a minimum of $15,000 per month in revenue.

When your customers don’t pay on time, it’s critical to have money in the bank to keep operating, and tying up valuable cash or operating lines with expenditures that can be leased can be a waste. When not used in day-to-day operations, cash is better spent in places where it provides the greatest return, such as developing products, improving your engineering/applications department, or hiring an additional salesperson.

Most people assume equipment leasing is for the business owner who can’t write a cheque to buy a machine, but my best clients are successful manufacturers with plenty of liquidity who choose to invest their cash in places other than equipment.

Another intelligent practice I see often is related to using leasing as a tax-friendly option.

Although I am not an accountant, from a taxation standpoint, equipment leasing normally is a method of adding capacity to the shop floor and profit while saving tax dollars.

Most of my clients write off their lease payment as an expense as they do for tooling, material, and wages. This makes the rate conversation even less important because if the payment becomes a writeoff, then the taxes saved are always greater than the interest charged.

Whenever a large transaction is being considered, it is important to talk with your accountant or financial adviser before proceeding.

Last, I know a client is in the right headspace when they ask about security.

The typical leasing company only has the piece of equipment itself as the collateral for the transaction, so it requires some form of guarantee or deposit. A typical bank loan is a heavily and sometimes overly secured transaction in which both corporate and personal assets of the owner are required as collateral. I am always amazed at my clients’ reactions when I tell them I have gotten them approved and all that is required is their corporate guarantee, which means the company is the only entity responsible for payments and no personal guarantee is required.

Because typical lease rates vary from those offered by a bank, it is very important to move beyond this discussion and ensure the proper questions are asked when evaluating whether it makes sense to proceed with the transaction.

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