A few decades ago, financing equipment was pretty simple. Call the banker and then place the order. But in the early 1980s, the auto industry began leasing fleets of cars to rental companies on a large scale and leasing soon became a viable option for everything from table saws to household furniture.
Today, leasing is the most popular way to finance both used and new machinery. Lease payments are normally considered rent, so they’re treated as an expense. (That might or might not have implications for taxes, depending on where you live, so check with your accountant.) Of course, you don’t own the equipment and the fees involved in leasing often exceed the interest on a loan. But leases aren’t tied to variable interest rates, so the payment won’t change. And the upfront cost (that “due on signing” fee) is normally lower for a lease than a loan — in fact, it’s often no more than an extra monthly payment — so there isn’t such a big bite taken out of the bank account.
When looking at whether to lease or borrow, that fixed payment amount is something to consider seriously in the current market. The Federal Reserve has said that it will keep a lid on interest rates until unemployment dips to 6.5 percent. Well, from a peak of roughly 10 percent in October 2009, the jobless rate has now dropped by about a quarter and has done so in a relatively steady and predictable manner. Through 43 months, it has fallen by an average of somewhere close to 0.06 percent per month to its current 7.6 percent. If the U.S. manages to continue the trend, we should break that magical 6.5 percent marker in about 18 more months (around the end of 2014).
Does that mean that a relaxation on the part of the Fed’s control over the money supply will lead to inflation?
It will almost certainly lead to higher interest rates and, as most equipment loans have variable rates, it will lead to higher monthly payments. So if a company is considering adding to its machine assets, this could be an awfully good time to do so. Demand for physical plant is definitely ramping up, but it’s still sluggish and manufacturers are still willing to be a little flexible on price or options or both. If inflation kicks in, the dollar cost of machines will rise. (You’ll spend more dollars, but they’ll be worth less.) However, if interest rates are going to rise, then borrowing to buy machinery will be a lot more expensive. And, if interest rates rise, leasing costs will rise, too. Timing is everything.
The buy or lease question is very subjective. Every situation is different because each woodshop is different. The decision really needs to be analyzed by an accountant, in part, because upgrading some machines will have a better payback than upgrading others. If there’s a notable lag in some phase of production, the solution might not be as simple as “let’s buy a faster machine.” Perhaps the process is flawed or the operator needs more training.
Once the numbers have been crunched and it’s obvious that some new machinery really is needed, then the lifespan of that equipment is the pivotal question: How long will it take to wear out or become obsolete? Will new technologies replace it before long-term financing is paid off? For example, will laser printing take over the manufacturing of parts that you now make on a CNC router? So far, printer technology can produce a plastic wrench. In six years, will it be able to make realistic plastic versions of the walnut automobile dashboards or gunstocks or chair parts that now occupy 20 or 30 percent of your manufacturing capacity? It sounds like science fiction and a very rapid time frame, but just a decade ago almost nobody had a cellphone and hybrid cars were still mystical beasts.
One factor to consider when financing used or new machinery is the ability to spread risk. If your shop mortgage and your operating loan and your checking accounts and current equipment financing are all done through one bank, you’re leaving an awful lot to the discretion of your business banker. By separating a new equipment purchase and running it through a lease at a different lender, you broaden your risk basis and preserve some of your borrowing power at the bank. You are, in effect, leaving yourself with more options if things don’t go exactly as planned.
Leasing sometimes offers another advantage, too. If the equipment supplier handles the lease, they might be willing to let you trade in your equipment halfway through the lease term and upgrade again if state-of-the-art advances change significantly. If you borrow and buy, you’ll need to sell what you have (if you can) and then borrow again to buy again.
There is also the residual clause. In many leases, you can buy the equipment at a set price when the term expires. If your specific machine works well for you and the industry has moved on to something else, your machine could now be difficult to find. Buying it for the residual price could be a very attractive option. On the other hand, if your business has evolved and you need to phase out this piece of equipment, handing it back to the leasing company might be a lot simpler than trying to sell it if you had purchased it with a loan.
When a banker looks at equipment financing, he or she is looking at two parts of the equation. Beyond your credit rating and past history, the banker will look first at whether or not the machine is good collateral for the loan (if he needs to sell it, will it fetch enough to get his money back?). But he’s also looking at the machine’s earning potential — its return on investment. In other words, exactly what difference will having this machine in your shop make to your monthly cash flow and, more importantly, to your annual net profit?
When leasing companies look at equipment funding, their primary concern is your creditworthiness. That’s because they already own the machine. They retain title to the equipment, unless you do a buyout at the end of the lease. So getting a lease could be easier than getting a loan.
Feel out three bankers before borrowing for equipment. Just because your dad always used a certain bank when he ran the shop doesn’t mean you can’t shop around. Your banker won’t call in every loan if he hears you visited the opposition. As long as you have a good history, he will be more likely to ask you what he can do to make it easier for you to stay with him.
The same holds true for leasing companies. Identify the machines you need, the suppliers and the best service options, get some numbers from the salesperson, ask your accountant about the ROI and then talk to several leasing companies about terms. These include upfront fees, monthly payments, length of the lease and the residual purchase price. Create a spreadsheet, so you can compare apples to apples. Get as much information together as you can, talk over how the equipment will augment production with your shop guys, take a couple of long walks to clear your head and get rid of the “it’s shiny so I want it” syndrome and then sit down once more with the accountant and crunch the numbers before making a decision. With leasing companies (as opposed to equipment manufacturers who offer various versions of machines and lots of options to go with them), the decision is almost entirely a numbers-based one.
In your quest for financing, don’t overlook the Small Business Administration. This branch of the federal government can help facilitate a loan for you with a third-party lender, guarantee a bond or help you find venture capital. In other words, there might be ways to finance growth without using the equipment as security. Keep in mind that the SBA doesn’t make direct loans to small businesses. Rather, it sets the guidelines for loans, which are then made by partners that include lenders, community development organizations and other entities such as private parties (venture capitalists, private investors and so on). The SBA guarantees that these loans will be repaid, thus eliminating some of the risk to the lending partners.
Another avenue that might be open to some shops is to work with a major client to secure financing. If your shop is the sole supplier of foil doors to a big-box store, they might be willing to partner with you on equipment that will reduce their cost or increase volume or eradicate shipping delays. They might guarantee a loan or provide one or even buy the equipment and lease it to you. That will all depend on volume and your history as a reliable supplier. But you’ve spent a lifetime being creative with wood. Why not do the same with financing?
This article originally appeared in the July 2013 issue.