Which Type of
Financing Makes More Sense For Your Business?
The first
consideration for most executives is evaluating the objective of the
transaction. Number one, is it owning equipment or using the
equipment that will be the source of future profits to the business?
“Invest in Assets That Appreciate In Value and…
Lease Assets That Depreciate in Value”
It is YOOJ accepted that “owning” business assets is
particularly beneficial when those assets appreciate in value—real
estate being a prime example. Most assets like computers and other
office equipment only depreciate in value, in most cases fairly
rapidly. When the objective is getting the maximum use out of a
(rapidly) depreciating asset, it is that “use” that brings profits
to the business, not the “appreciation” of the asset itself.
Maximize the use...minimize the investment.
Leasing Makes Business Sense and Tax Sense
Most businesses will write off 100% of their lease expenses.
Bank loans for equipment must be capitalized and only gradually
depreciated over a period 5, 6, 7 or more years! Operating leases
can even effectively accelerate those write-offs even faster,
putting your cash, into your pocket sooner.
A Complete Solution
A typical lease covers as much as 110% of the equipment cost because
it also covers the delivery, installation and other soft costs--in
addition to the equipment itself. Our leases only require one (or
two) month’s rent in advance; there is a UCC filing only against the
specific equipment leased; and the leasing company won’t bother you
for the next 3-5 years as long as you make your payments. At the end
of that time, just return the equipment (with no further
obligation!) and upgrade to new equipment, or the leasing company
will sell you the equipment for its then-current fair market value
(probably minimal); and you will have fully expensed the
payments for tax purposes (unlike a term loan or credit
line).
Is That “Prime Rate” Offer a Good Deal?
As you probably know, there is not a single prime rate; rather each
bank is free to establish their own “prime” rate—sometimes it is as
low as the Wall Street Journal prime, although we’ve often seen
individual bank’s prime (their best rates to their best customers),
set as much as 4 points above the benchmark WSJ-published rates.
Lets assume for the sake of this example that your bank has offered
you this month’s (March ‘05) WSJ prime rate of 5.5%, “plus 1.5
points.”
Let’s Talk Rates…
Obtaining a bank loan at such a “low” rate usually requires that you
keep 20-30% of the loan amount in non-interest bearing,
“compensating balance” accounts at that bank. Using the lower 20%
figure for example, the bank is really lending you 80% of their
money and 20% of your own money.
Is It
7%, or 17%?
When you compute the real yield on that 7% loan offer, you find
it is actually a 17% loan. (Because you’re paying interest on
100% of the loan amount, but have only received 80% of the money
from the bank, the rest is your own compensating balance
being “loaned” back to you). Using the same formula, a 10%
compensating balance brings the bank’s effective loan rate “down
to” 11.7% Anyway you cut it, that’s a far cry from 7%!
Some executives say,
“we keep $10-20,000 in their checking account anyway…” Perhaps so.
But that’s your business decision, for your convenience, today. With
a compensating balance clause in a bank loan, it becomes a
requirement. Fall below that figure for any reason and you
are in default on your loan. Change financial institutions or
move to a “sweep” account format for example and again you would be
in default. It’s all in the fine print.
What Else Is In The “Fine Print?”
Plenty. The following is a list of issues that have come up for many
of our clients examining the same lease vs. bank decision. Here are
some “bullet points” to compare and contrast typical commercial bank
terms with YOOJ Solutions lease
terms. There are many critical differences.
“Bank Fine Print 101:”
-
Bank line rates
float with interest rates
-
Lease
rates are guaranteed fixed for the tem of the lease
-
Short-term rates are low now, but on their way up—where will
they “float” to during the next 12, 18 or 24 months?
-
Do you have an
existing line of credit at the bank?
-
Is the
bank actually offering a credit line or a term loan? There are
many key differences:
-
Most
banks require that credit lines be brought to zero at least
once every 12 months. They want to reserve the option to
call the line should your industry start to “go south,” or
if the regional economy, or your own business prospects
start to “soften” (In their sole opinion).
-
Where would you be if the bank elected not to renew in 12
months?
-
Banks typically
do not fund more than 75-80% of the net hard equipment cost.
-
Our lease can cover as much as
110% of the cost as, unlike your bank we will include
shipping, training, installation, initial maintenance and
other “soft” costs.
-
Banks are far
more restrictive than leasing companies, about the equipment
they will finance.
-
Many banks
will only do “hard” collateral (machinery, etc.)
YOOJ Solutions will
lease all kinds of business or commercial equipment, even
100% software transactions.
-
Most banks will not even
consider “used” equipment. We do it all the time!
-
The bank will
place a “blanket lien” on all of your assets.
-
Our UCC will
be filed on the leased equipment ONLY. Nothing else is
encumbered. None of your financial flexibility will be
compromised.
-
Keep in mind that if the bank
were to decline to renew your line (at any point in the
term) that those “blanket liens” would still be in effect,
blocking your attempt to use your own assets as collateral
for any new (replacement) funding.
-
Most banks
require ongoing financial disclosure. Make no mistake about it,
with a bank line you have a new “partner”. Almost every
bank will require you to submit annual or quarterly financial
statements and/or tax returns for their review. Further, bank
loans are often conditioned on your maintaining certain
bank-specified key financial ratios. Working capital tests,
debt-to-equity, current and quick ratios are commonly used and
specified.
-
Will this
hinder your ability to run your business, as you deem
prudent?
-
It is routine
for banks to restrict your access to any new debt
obligations from any other sources without their
express consent—and you cannot assume that you will receive
it.
-
If you fall
below the bank’s mandated ratios, you will be in
default.
-
There are absolutely no
financial reporting requirements with a
YOOJ Solutions lease.
-
The bank will
likely require you to cross-collateralize any new obligation
with all of the accounts you maintain at that
institution—personal checking, savings, trusts etc. (this is
often buried in the fine print)
-
Even if you are not signing
“personally” for this obligation with your bank, you may find
that any previously signed, personal guarantee is deemed
“continuing and unconditional” vis-à-vis all new obligations at
that same institution.
-
Banks fees and closing costs
typically run 1-4% of the transaction amount. These fees can
have a significant effect on the real interest rate you are
paying. Ask for a copy in writing before you sign…and do the
math.
-
Are you a “key
customer?” That may sound flattering, but it usually means that
the bank is extending its offer based on your “entire banking
relationship”—your other accounts, the other balances that you
maintain and the service fees/income that you generate for them.
-
Are bank-mandated “compensating
balances” your best use of your own cash and operating capital?
Where else could those funds be working (earning) for you, if
they were not committed” to the bank line?
-
The bank can call your loan! There
is probably a clause that permits the bank to call your loan if
they feel “uncomfortable” about the prospects for your industry,
without regard to your payment history. (This too is
often buried in the fine print. Check it out.)
-
Merger
Mania—Banks are “merging” and restructuring all the time.
Your bank may be purchased by another bank. The surviving bank
might have different lending criteria or may not like your
industry, or the equipment. Because default provisions are so
loosely worded (intentionally); they probably have the ability
to call your loan. They get their money back, you may be out in
the cold.
Are You Ready To Pay These Very High Prices…
For Those “Very Low Rates?”
Most customers find that they are being asked to pay a very high
price for those seemingly “very low rates.” Operating & financial
restrictions, capital “frozen” as unproductive “compensating
balances,“ business assets encumbered, future rate float risk,
reduced availability of their own critical business credit lines
etc., etc. Leasing has become a trillion dollar industry right
alongside the commercial banking industry and for good reason. The
points we have raised are just some of the many reasons why
businesses from giant multi-nationals to local “mom & pops,” have
decided to “just say no” to their bankers overtures and have chosen
to lease instead.
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