One of the ways that business owners and managers access incremental capital for business operations is through the refinancing or recapitalization of equipment that is owned outright by the company or nearly owned outright with significant equity in the assets to leverage.
We call this refinancing because in most cases the equipment was previously financed and since been paid off. For longer use types of equipment, there can still be an opportunity to refinance the assets a second time around in order to inject capital back into the business.
While this practice does work and in theory sounds reasonable to most, there are some things to consider when crunching the numbers.
First of all, most sources of equipment financing will only recapitalize or debt finance 65% to 75% of the appraised forced liquidation value of owned equipment.
So if you think the orderly liquidation value of your assets is $1,000,000, the forced liquidation value may only be $750,000, which can make quite a different in the amount of funding that can be made available.
Second, the financing that is available is not typically prime plus three or four, its more like prime plus nine or ten as the financing is on used equipment that has not gone through a sale transaction to crystallize value or go through a condition review by a dealer. The higher cost of financing is not in itself unreasonable and can be explained in terms of risk to the lender, but it still needs to be factored in to the cost of financing you can expect.
In situations where the business is in financial distress, the cost of financing will be even higher, likely falling somewhere in the 18% to 24% per annum range.
Third, most of these transactions will need to be done through a sale and lease back transaction where by the financing or equipment leasing company purchases the assets from the business and provides an equipment lease back in return for a defined period of time. The sale and lease back transaction can potentially trigger income tax effects due to the fact that the assets are being sold, so this also should be factored into the transaction.
Fourth, the process, especially for the lower cost sources of equipment refinancing, is going to take some time. Third party appraisals are typically required as well as background searches on the assets to make sure a clear title is available to the financing company. The entire process from application to funding can take 30 to 60 days to complete. Faster money is typically going to be more expensive money, so its important to plan ahead and not leave this financing option to the last minute.