YOUR COMPANY IS LOOKING FOR SALE AND LEASEBACK SOLUTIONS!
HOW TO DO AN EFFECTIVE SALE LEASEBACK TRANSACTION
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Sale leaseback financing is an often underutilized part of the Canadian Equipment and Leasing industry. Many business owners and financial managers in Canadian firms may not yet be aware of the wide popularity and increasing use of this alternative financing facility. For various economic and financial reporting considerations, this finance strategy continues to be scrutinized as a financial option for Canadian businesses. Let's dig in.
Sale and leaseback financing is a process whereby your firm can sell an asset and lease it back from a financial firm, typically a leasing company, the ' buyer lessor,' as it pertains to equipment, or a mortgage firm of some type if it pertains to a real estate investment,( sale lease-back commercial real estate ) such as owner owned premises.
When you negotiate such financing, you can set out terms of repayment, typically the term of the transaction and payment schedule. As a seller of the asset, your firm effectively becomes a lessee, with the financial firm becoming, of course, the ' lessor '.Your firm is the ' seller lessee' with ownership reverting back to your firm at the end of the lease.
SHOULD YOU CONSIDER A SALE LEASEBACK ARRANGEMENT
Companies that are capital intensive via investments in fixed assets, equipment, or real estate and Rolling Stock are typically great candidates for leaseback financing. The ability to recoup some of the cash in past investments in times of need is the common reason for considering this type of financing. When a company looks to avoid external financing, leasing back owner-owned assets makes a lot of sense, especially if there is a consideration for a company's debt-to-equity ratio.
Although the transaction does, in fact, show up as debt on the balance sheet, that debt goes down with each installment, and the company has an offsetting infusion based on the cash received in the transaction. The process can sometimes be confusing to owners as it is really a combination of sorts of debt and equity financing under the cash received.
EXAMPLE OF AN EQUIPMENT SALE LEASEBACK DEAL
Let us assume a transportation/trucking firm has a significant investment in the purchase price of its truck fleet. At the start of the transaction, the trucks are unencumbered with liens by virtue of the assets' ownership. The trucking firm sells the trucks to the commercial leasing company at an agreed-upon fair price which in some cases can actually be higher than the accounting ' BOOK VALUE ' of the trucks.
The proceeds of the transaction are typically used for any general corporate purpose, for which there might be several reasons. This financing transaction works well when your firm has the ability to pay back the installments on the transaction, and the commercial lender has a comfort level around your financial statements and the understanding that the transaction has a long-term benefit to your firm.
The borrower must prove proof of ownership of the asset or assets in question, and it's important to allow for time to close the transaction given that it has a bit more complexity and paperwork than a traditional lease financing transaction.
WHAT ARE 8 BENEFITS OF A LEASEBACK TRANSACTION -
1. This is an accepted way of raising capital that has a couple of key benefits :
2. The company has the right to use the asset for its original purpose still
3. Your firm receives a cash injection based on the amount of the transaction and can preserve existing credit lines or loans with other lenders, allowing your company to maximize cash flow drawdowns
4. It removes the firm's potential requirement to raise additional equity capital, which would dilute ownership holdings - Some experts have compared the transaction, however simplistic, to a pawn shop transaction, whereby the owner has an asset/assets and requires temporary cash. The difference in that transaction is that the seller in a leaseback is committed to regaining title and ownership of the asset!
5. Financing rates are competitive with general market conditions and your overall ' credit profile' as they relate to lease payments.
6. While traditional Equipment Lease Financing solutions might require a down payment on the transaction, leasing back an asset typically does not require a downpayment, sometimes called ' the downstroke '!
7. With business interest rates being at all-time lows for the foreseeable future, companies have the ability to take advantage of those low rates
8. Balance sheet improvement - allows the company to reduce fixed assets and increase ' cash on hand.'
In some cases, your firm might enjoy some tax advantages around leasebacks and the rent payments on the transaction.
The overall leaseback transaction strategy has been around for a very long time and, as noted, continues to gain in popularity. The primary reasons for its increasing usage are the ability of business owners to enhance their profits to a certain degree and, even more importantly, to generate additional cash flow for the business.
That is the key benefit of the latter would appear to be the most obvious benefit. Business people continually look for 'creative' solutions to financial and cash flow challenges. Who wouldn't want that? Luckily these days, more and more alternative solutions to cash flow needs are around. The basic strategy?
It's simple. Your firm has equipment that has been fully paid for and is currently unencumbered collateral. Your interests are simply that you wish to take advantage of the equity in the equipment, but at the same time, you wish to continue to use the asset.
LESSOR APPROVAL CHARACTERISTICS
At 7 Park Avenue Financial, we talk to clients about 3 key issues in ensuring faster approval.
1. The ability to demonstrate clear ownership of the asset, free from encumbrances
2. Mutual agreement of borrower and lender of the value and age of the asset and an acceptable interest rate to both parties - The transaction can be long-term or short-term in nature.
KEY POINT - In many cases, it is very appropriate for some additional cost around a 3rd party appraisal by a qualified Equipment Appraiser to determine the full proper current market value of the asset/assets
3. The borrower's ability to demonstrate the true value and use of the asset in generating sales and profits for the firm. Naturally, the asset base of consideration for such strategies involves a broad number of industries and an even broader number of assets.
More often than not, the need is fundamental - how can you leverage assets to bring more cash into the firm? In certain cases, if a transaction is managed properly, you can enhance your overall financial statement ratios. So, ask our clients, how does it work? You 'sell' the equipment back to the finance or leasing company.
Under the umbrella of equipment financing and lease documentation, your firm 'leases' the finance firm's assets back. There are, of course, some key accounting issues that Canadian business owners and financial managers have to take into consideration.
Based on the transaction's value, your firm may have to book either a gain or loss on the transaction. The ability to capitalize on cash received will always be a key consideration as other financing arrangements your firm might have in place, such as lines of credit, etc., stay intact.
What are some of the other motivations for considering such a strategy? We can broadly group them into a couple of categories - i.e. Cash flow, accounting and tax, balance sheet, and income statement enhancement. If your firm structures the transaction as a true operating lease, you have somewhat magically taken debt off your balance sheet and improved many of your key operating and loan covenants when you enter into the sale-leaseback.
Payments create a monthly expense. More often than not, this amount is less than the depreciation taken on the asset, so, via the magic of accounting, your firm has created additional earnings! In cases where you do, in fact, have a 'gain' on the sale-leaseback, those also, of course, add to the profits of your firm. We love those accountants, right?!
In summary, Canadian business owners and financial managers should investigate the sale leaseback strategy of assets. In the current economic environment, such a strategy can enhance your firm's overall liquidity and profitability. That's a good thing.
KEY POINT - Entering into the sale leaseback consideration, there should be a solid understanding of issues such as balance sheet effects, interest rates and financing costs, the difference between a CAPITAL LEASE and an OPERATING LEASE and the purchase option at the end of the term of the lease term
( A higher purchase option has the effect of lowering the monthly payment on a financing lease transaction )
DISADVANTAGES OF A LEASEBACK
In evaluating a commercial financing transaction of this type, it is sometimes easy for inexperienced business people to misunderstand this type of transaction, so your firm's goal should be to understand what the financing can do for your firm, ensure you understand any potential risk or disadvantages, as well as understanding how the transaction process works. The one clear and simple disadvantage of the transaction is simply the asset's non-ownership - many companies have a pride of ownership mentality.
Another potential disadvantage is the potential complexity of working with any existing lender or, most importantly, your senior lender to get the asset released from their security - this is accomplished through a simple waiver process.
Additionally, proper consideration should be given to the amount of depreciation and obsolescence of any given asset or asset class and the consideration around an operating lease vs finance lease. Due to changes in worldwide accounting rules off balance sheet financing does not always have the same benefits it used to have.
HOW TO EVALUATE A SALE-LEASEBACK
Generally speaking, a sale leaseback makes sense when assets transferred have value and are appreciated (real estate ). Alternatively, they are revenue and profit-producing assets of the business. Assets that aren't critical to the business's use are often sold and deemed as not core to a company's operations.
But the refinancing process we have outlined releases equity in assets you own and can provide valuable working capital when it is really needed.
CONCLUSION - SALE LEASEBACK TRANSACTIONS
Companies have the ability to consider numerous benefits of the leaseback transaction process. It is important to ensure that the appropriate business, tax, and accounting considerations are taken and assessed properly. Utilizing this financing strategy allows companies to benefit from tax issues related to sale leaseback accounting and utilize the cash to grow sales revenues, clean up the balance sheet, and reduce other more expensive debt.
There is probably no typical sale leaseback - but sale-leasebacks are a great way to access business capital for several reasons. Seek out and speak to 7 Park Avenue Financial, a trusted, credible, and experienced Canadian Business Financing advisor to ensure you are working with the right sale lease-back companies.
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