Finding the Money
Planning to expand? Add new equipment? Financing growth in a changing market is no easy task for most companies
Industrial Distribution - May 1, 2004
By Phillip M. Perry
Contributing Editor
The economy is improving—or so most of the indicators tell us. Gross domestic product is increasing at the fastest rate in nearly two decades, according to the U.S. Department of Commerce. Business productivity, corporate profits and consumer confidence are all on the rise.
So is now the time to invest in new equipment and physical structures? If you're like most business people, you're asking that question because you're looking for ways to grow your business. After all, you want to do more than run in place for the next few years.
The big risk of expansion, of course, is that the rebounding economy will take longer to get up a real head of steam. Everyone is looking at the unemployment figures, which are edging downward but don't yet indicate a strong hiring rebound. Many are nervous that stubbornly high unemployment figures could put a damper on a robust recovery.
That's the downside. On the plus side are the low interest rates that favor investing for the future. The cost of financing is at the lowest level in decades.
"For people who have the need for equipment, this is a great time to buy," says Norm Hall, vice president of equipment finance for the western sales region of the CIT Group. "I think the cost of capital will stay low for a while."
Businesses are torn in two directions.
"These are the best of times if you're borrowing money," says Don Schackne, president of Personnel Management and Administration Associates in Delaware, Ohio. "But when I tell my clients they should invest for future growth, I still see a hesitancy to borrow and invest. They tell me, 'Well yeah, the stock market is up but the employment figures are not that great.' People are taking a 'wait and see' about extending themselves before the economy proves itself."
To lease or to buy?
The economy, then, is still causing jitters among business owners. But maybe you want to get in on this interest rate thing while the getting is good. One thing's for sure: If you're looking to justify investments in this economy, you must put pencil to paper to determine your options. And question number one is this: Should new equipment be leased or purchased with borrowed money?
One of the most commonly cited advantages of leasing is the ability to conserve cash for use in operating capital. If you take a loan, you have to make a down payment, and the loan finances the remaining amount. In contrast, you skip the down payment when you lease. Further, you finance only the value of the equipment expected to be depleted during the lease term. Often you have an option to buy the item for its remaining value at the end of the lease.
Also, a loan customer bears all the risk of equipment devaluation because of new technology. In contrast, a lessee transfers all risk of obsolescence to the lessors, as there is no obligation to own equipment at the end of the lease.
Furthermore, lease payments can be classified as operating expenses rather than as debt, so the transaction may not affect your future borrowing capacity. Finally, you can usually get 100 percent financing of equipment with leasing, whereas borrowing may only provide up to 85 percent of the cost.
A survey conducted by the Equipment Leasing Assn. found that "73 percent of small businesses lease equipment, citing the top three reasons to lease as the abi-lity to manage company growth, take advantage of the latest technology, and improve asset management."
But there are also benefits to borrowing and buying: You may pay less in taxes when you deduct the depreciation that comes from owning. And should you want to retain your new equipment after the conclusion of the financing period, you may well benefit financially from buying rather than leasing.
Finally, from the standpoint of cost of money, you are removing the middleman.
"You often end up paying more when you lease, since you are using someone else's money, which they have already paid to borrow," says Schackne, who has seen some financial structures in which the end user is paying a lease rate 2.5 percent greater than the borrowing cost would have been. If your business has a strong credit profile, you may have access to funds at lower interest rates and thus may be better off borrowing. And there seems to be plenty of money available if the applicant is right.
"Here in central Ohio, I am not seeing banks hold back," says Schackne. "Banks are advertising that they are trying to get business, including commercial loans."
Schackne says it's the very hesitancy of business people to extend themselves that's causing banks to market themselves aggressively. That's good for interest-savvy borrowers looking for a better deal.
Leasing makes sense
So, borrowing and leasing both have advantages. While your accountant must determine the best move for you, the decision may be driven in some cases by the greater availability of funds at leasing companies. While it's true that banks are eager to lend money, it's equally true that, over the course of the last few challenging years, many have adopted the habit of taking a harder look at borrowers. That hasn't changed. In contrast, leasing companies are, in many cases, hungrier for business and may be more willing to open their wallets.
Members of the ELA are reporting an uptick in demand for their services as the economy turns upward.
"I can't say that we are getting double-digit growth, but we are heading in that direction," says Ralph Petta, vice president of industry services for the Arlington, Va.-based trade group. "Just as manufacturers have drawn down their inventories and need to replace more, so are many sectors of industry starting to replace some of their equipment. Generally, as businesses decide to refresh their technology or acquire other productive assets, leasing takes its share."
And the current low interest rate situation: Does it favor borrowing or leasing?
"Conventional wisdom has it that in low-interest environments people will borrow money with traditional bank loans rather than lease," says Petta. "Our figures indicate this has not been the case over the past 20 years. No matter what the interest environment, leasing seems to get a penetration rate of 30 to 32 percent of all capital equipment investment."
In 2003, for example, leasing companies accounted for 31 percent of the $668 billion in the capital equipment portion of the gross domestic product.
"Companies lease for economic reasons not necessarily connected to interest rates," says Petta. "In many cases, they need equipment and they want to retain cash flow flexibility."
Also working to balance things out is that leasing companies obtain their own capital on the open market, at terms similar to any other industry. Thus, when interest rates go down, they are able to obtain money cheaper and thus offer more attractive deals to clients.
Despite these truths, there remains the perception that low interest rates favor borrowing. That perception can hurt leasing firms when borrowers tend to drift toward traditional lending institutions. That drift, in turn, is good for business people who patronize leasing firms because many of the latter have become entrepreneurial in how they structure payments. That mindset is still in place. As a client, you can enjoy a flexibility that you don't have with a bank.
"Leasing is still a very competitive business," says Petta. "There has been no change in openness to negotiation in the past year. Leasing companies are still very flexible when it comes to terms."
The bottom line: Go shopping. Look for some younger and leaner leasing companies that may be open to negotiating more aggressive deals that work to your advantage. Many will work hard to tailor favorable pricing, payment schedules, end-of-lease options, and other components. Since you will be dealing with the lessor for many years, find a financing partner whose style fits your own. While the cost of capital is important, so is the personality and approachability of the firm.
"We have 750 members," points out Petta. "There are all kinds, shapes and sizes of leasing companies. Many are looking to establish relationships now, and these are the ones that may be willing to do the transaction based on the needs of the lessee."
Knowledge is power
Deciding whether or not to expand your business is never easy. The answer lies in a combination of pencil sharpening, option searching, and seat-of-the-pants assessment of the economic winds. Information abounds on obtaining capital and making the lease-vs.-buy decision. Associations like ELA, Internet resources, and books on the subject can help companies determine how quickly, and by what means, to lay the groundwork for future growth in these changing times.
If you're looking to make a business loan or lease equipment, BuyerZone can quickly provide you with free quotes from multiple lenders.
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