Sale leasebacks free up cash

Without question, one of the biggest struggles for Canadian manufacturers is managing cash flow. This is a problem regardless of whether the shop is busy or slow because maintaining enough monthly funds to cover overhead can be a challenge even in the best of times.

There is no question that given the choice between an outright purchase of equipment or entering a lease or loan transaction, it is much more palatable for manufacturers to avoid the cost of borrowing. However, when shops are busy, the costs of labour, tooling, and materials can put a lot of pressure on cash flow.

Manufacturers incur costs for delivering parts upfront, but payment normally is 60 days (or more) after delivery, so even in good times, paying the bills can be tough. In other cases, lags in landing orders, even from very loyal customers, can happen for reasons beyond anyone’s control – COVID-19 is a textbook example of that.

Keeping staff and materials available while in a holding period applies a lot of pressure to a company’s cash flow. One solution to this problem is entering into a sale leaseback with a lender who understands both the equipment and the industry.

What Is a Sale Leaseback?

A sale leaseback is a transaction in which an asset’s title is conveyed, at an agreed-upon price, to a financial institution in exchange for a lump-sum cash payment.

The asset’s owner leases it on a long-term basis while retaining exclusive possession and use, but no longer technically owns it again until the transaction has been paid back in full. This type of financing works extremely well for good brand-name machine tools because, when maintained properly, they consistently hold their value.

As an example, I have a customer that had leased a new $200,000 VMC over a five-year term. When the original lease was paid in full, the customer took ownership of the machine. Since that time I have, on two separate occasions, raised money using a sale leaseback with that same machine when the company required working capital.

The point here is that even an older machine tool still maintains enough value that a lender with manufacturing industry experience should have no problems providing funds against its value. Other than property, I cannot think of any other asset that holds its value long enough to be used as collateral for a lease on more than one occasion.

How Much Is It Worth?

When it comes to figuring out a machine’s sale leaseback value, a number of factors are involved.

The Association of Machinery and Equipment Appraisers (AMEA) is the premier international organization for certified equipment appraisers. It specializes in appraising machinery and equipment, and I am very fortunate to be a member of this association. Here are a few of the more important aspects that a certified appraiser considers while valuing a piece of equipment:

1. Machine Builder. There are many different machinery manufacturers, all of which have their place in the market. That being said, a high-end machine built in Japan, Taiwan, Korea, Europe, or the U.S. holds its value better because historically these machines, when properly maintained, are known to hold their tolerances for many years and companies from these jurisdictions have a proven install base.

2. Usage. This is very important because the same machine can be used to manufacture a variety of different parts across numerous industries, and there are plenty of differences among manufacturing environments. And two machines of identical age could have vastly different values depending on how they were used.

An average machine tool is run approximately 2,000 hours per year (one shift per day). However, the automotive industry is known to run machines much harder (in many cases, two or three shifts per day), so two identical machines of the same age will be valued quite differently to account for the additional usage.

3. Condition. In the world of machine tools, this means maintenance. The amount of maintenance a machine tool requires is related not only to its usage, but also to the type of material it processes.

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

Once value has been established, the next step is to ensure that you own the asset with no restrictions. Because the machine itself is the collateral for the sale leaseback, it is very important to have full title of it so it can be conveyed to a lender.

It sounds simple enough: You buy a machine tool and pay for it, therefore you own it and can borrow against it. However, there’s a good chance you have a General Security Agreement (GSA) with your bank that includes all of your assets.

A GSA provides the bank with a security interest in your inventory, accounts receivables, equipment, and other assets to cover its lending risk. Every piece of equipment that is purchased, even if it is paid for in cash, is automatically included in the GSA; therefore, the bank has a first say in the title of the asset.

The sale leaseback transaction still can proceed easily if the bank provides a waiver to the lender that relinquishes its interest in the piece of equipment that is being used to raise funds. This is a common request for any bank. As long as the borrower isn’t in financial distress and is current with all banking obligations, getting the waiver normally is a non-issue.

A manufacturer’s biggest pain point is managing cash flow regardless of whether it is in a position to take on a large order and expand or just trying to get through a tough stretch. Knowing all the different avenues to access capital may be the one piece of information that will determine if it makes it through tough times.

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