There are times when a business has considerable equity in their existing assets would like to undergo equipment refinancing to leverage that equity for working capital, debt consolidation, or business expansion.
In order to accomplish this, the business can either get a term or demand loan against the identified assets or undergo a sale and leaseback transaction with a leasing company.
With respect to a term or demand loan, this is can be provided by any number of financial institutions, but regardless of the lender you speak to, this type of equipment refinancing will only take place if the existing cash flow of the business is capable of servicing the debt.
If the business is in a situation of distress or development, where cash flow is projected to be solid, but isn’t at the present time, it is less likely that a term or demand loan can be secured.
An equipment loan provides very little financial disruption to the business as the equipment pledged as security remain in the ownership and control of the business owner or owners.
A term or demand loan lender will also require first position security so it will be important that no general security agreement is in place against all business assets, or the GSA holder is prepared to remove the equipment you want to refinance from their GSA.
A sale and leaseback transaction will require the sale of the equipment to a leasing company in exchange for a capital or operating lease and the exclusive right to use the equipment for the term of the lease. Most sale and leaseback transactions provide capital leases where the business will repurchase the equipment at the end of the lease for a nominal cost.
Because of the change of ownership requirements, sale and leaseback transactions can trigger income tax effects so its important to review a proposal for this type of equipment refinancing with your accountant before going forward.
Asset based lenders and leasing companies that offer sale and leaseback equipment refinancing will consider situations where the business has cash flow distress or is looking at expansion to increase cash flow. The effective financing rates in these situations will be higher than for a company with a stable cash flow.
The amount of business financing that can be secured for either loan or lease is going to range from 50% to 75% of forced liquidation value of the equipment that you want to refinance.
The forced liquidation value will be established either by a third party appraiser or through the lender’s own internal equipment appraising resources.
Terms for repayment will typically range in the three to five year period, depending on the assets and the financial and credit profile of the business.
If you are in need of equipment refinancing or want to know more about it, please give me a call and we’ll go over your requirements together as well as potential options that may be available to you.
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.
In the wake of the most recent recession that started during 2007/2008, the sub prime lending market for both residential and commercial properties all but disappeared as many institutions were not able to survive the red ink being split all over their balance sheets.
But over the course of the last year or so, more an more sub prime commercial property financing sources have been popping up in both Canada and the U.S.
In some cases, its hard to even call these lenders sub prime as many are after the very same business that is currently being done by the major banks and secondary institutional lenders.
While the economy slowly strengths, drawing lenders back into the market, there is a slight change in market dynamics due to the behavior of the major banks towards deals that are a notch or so below a grade “A” rating.
This has created more demand in the market place for the types of lending sources that are still after solid commercial property financing deals, but willing to bend the requirements slightly here and there to get the deal done.
In the past, this was almost the exclusive domain of the front line, major brands.
But since the recession, requirements for business financing have not only become more stringent for the larger commercial mortgage deal, but also very time consuming as major lenders continue to react slowly to less than perfect financing opportunities.
Even for commercial deals that fit the lending box of the majors, the time it takes to get a deal done can take several months and loads of red tape to get completed.
Cue the sub prime or alternative mortgage lender.
These commercial mortgage lenders are also neither private mortgage lender or mortgage investment corporation.
They typically have a handful of very wealthy investors, which in some cases may be institutional lenders that are moving down market to operate through someone else’s business model.
These lenders are looking for the border line “A” deals, the A minus deals, and the B plus deals.
Cash flow, security, and credit are still very important, but there is less of an emphasis on some of the extensive due diligence requirements that you will find when working with front line lenders.
This type of funding source is also interesting to borrowers that might be able to qualify for a slightly better rate at a major bank, but don’t have the time or don’t want to invest the time and effort going through the application and approval process.
The alternative property financing market tends to work strictly through brokers with very little if any front line advertising or promotional efforts of their own.
In many instances, these lending groups will set up a number of different funds to target different risk profiles and/or property types in order to match up better with the return and risk expectations of a specific group of investors.
There is a lot of money out there trying to find a home, and commercial real estate mortgage financing in the right markets is very appealing to a certain profile of investors these days.
While there can be considerable range in the amount of financing that can be provided, the minimum deal size is typically several million dollars with the maximum size topping out at several hundred million.
With rates be relative to risk, you can find deals in the market that are very close to the conventional market for similar commercial property.
If you’re in the market for commercial property financing, this might be a category of lender that you should be considering.
If you are a company that is more than two years in business, has established cash flow and credit, then equipment leasing can provide an incredibly valuable form of business financing leverage to you.
To be clear, equipment leasing can also be available to start ups and companies with less than two years of operating performance under their belt, but in those cases, the leverage than can be acquired is more similar to equipment loans or business loans for these types of companies.
For more established companies, equipment leasing solutions can provide financing amounts at or near 100% of the cost of the asset, and in cases where there are delivery, installation, and even training costs, these can all potentially get financed into an equipment lease as well.
Traditional business financing facilities provided through banks and institutional lenders will top out at the 75% to 90% lending range for the value of the equipment.
Leasing companies, on the other hand, can be much more aggressive with the financed amount, requiring very little money down, and many times only requiring the last payment on the lease in advance.
When you look at the overall balance sheet of a company, lower rates typically are linked to debt equity ratios ranging from 2:1 to 3:1, but if you’re generating enough cash flow, businesses like transportation companies can get up to 7:1 or higher debt equity ratios through the use of equipment leasing facilities to maximize the potential leverage of their equity.
For companies that still fall into the 2:1 to 3:1 debt equity ranges, equipment leasing is more likely to come in at or near 100% of the asset value due to the strength of the balance sheet.
Even in cases where a bank or institutional lender may beat out an equipment leasing company on rate, the business owner may still want to take the lease financing deal if he or she can go from say 75% loan to asset value to 100% or more.
This an be an enormous benefit to cash flow as available cash can be deployed into working capital to fund more inventory, more wages, more receivables which all can lead to higher profitability.
That being said, the equipment financing world can be very competitive, especially for companies with a strong balance sheet, cash flow, and credit rating, providing you with the opportunity many times to get both great rates and higher leverage through equipment leasing.
This is also an area where a business with strong financials can negotiate a better deal among competitive sources by better understanding just how far a leasing company will go to get their business.
When you’re looking to finance a commercial real estate property, there may be some better short term options available than the bank.
Let me explain.
The commercial property financing process with an institutional lender is a time consuming process.
More specifically, it will likely take 60 to 90 days from the time you apply for a commercial mortgage to the time its approved and funded, or even longer.
Banks and institutional lenders are the preferred sources of commercial property financing because of the lower rates they can offer, and when you’re working with a mortgage at or above million dollars, every percentage point is going to be important.
But even more important is getting financing in place when you need it so you can avoid 1) missing out on a property acquisition, 2) take advantage of a profit opportunity, or 3) avoid incurring a cost.
Business financing should always be about the net cost of funding, not just the stated interest rate. And when it comes to getting something done in a hurry or in a predictable period of time, banks and institutional lenders are not that predictable in terms of indicating if they will fund a deal, and then when it will actually be funded.
So if time is of any concern to you when arranging a commercial mortgage, you may want to consider a private mortgage lender before even going to the bank.
Because a private lender can potentially get the lending / funding process completed in 30 days or less, providing an avenue to get capital in place when required, even if you have to pay a bit of a rate premium to do so.
And in today’s market, if you have a great piece of property and the loan to value required on financing is under 60%, the private mortgage lending rates can come very close and in some cases rival what a bank or institutional lender could provide.
Then, with business financing in place, you can take your time surveying the market and getting the best available deal where you are in control of the process and not in a take it or leave it type of scenario with time running out on the clock.
This is where the net cost of the transaction comes in.
If you end up paying a few extra dollars in interest over a year or two, but end up saving or making ten times that amount or more from having financing in place when it was required, then the cost of a private mortgage becomes cheap compared to the cost of not having the financing in place when you needed it.
If you’re at all pressed for time when trying to finance a commercial property, it can be very dangerous to assume that you won’t run out of time with a bank or institutional lender, or that the terms and conditions you’re going to sign up to for the long term are going to be acceptable to you.
There can definitely be a significant benefit attached to the potential incremental cost of an asset based loan and at the very least, the incremental cost is insurance to make sure your deal get done, or funds are available when they need to be for other purposes.
If you run a business that has good commercial real estate in your asset mix, then you need to make sure that you’re getting the best value out of the leverage that real estate can provide.
Regardless of whether you’re trying to arrange business financing for across your business entity or just focusing on getting a commercial mortgage for piece of property you own or are trying to acquire, don’t underestimate the power of the real estate security that is being offered to the lender.
When you’re looking at full balance sheet financing through an institutional lender where A/R, inventory, equipment, and real estate are being collectively leveraged to provide you with the amount of financing you’re looking for, the strength of the real estate will impact both the overall rate and total leverage you will receive.
Unfortunately, many times business owners don’t break things down fine enough to understand what the real estate is contributing to the financing package and in many cases do not receive optimum financing value from the commercial property or properties they own.
The same is true for arranging a stand alone mortgage on a single property where the offerings you get back from bank or institutional lenders may not be considered optimal or superior to what you should be able to acquire.
This is one of the main frustrations of commercial financing in that commercial lenders are totally portfolio driven, so if their portfolio has a higher risk rating than its supposed to, or they already have a lot of your type of property in their investment mix, the offer they make isn’t going to be as strong as compared to when the portfolio is balanced more in your favor.
And if you’re not in a highly competitive market area, there may not be a lot of other options to chose from. Or even if there are, you may not have enough time to go look for another option right now.
One solution to this type of situation is to consider a certain amount of asset based lending from private mortgage lenders.
In certain situations, private mortgage lenders may be offering very similar rates to banks or institutions, especially on grade “A”properties pledged by solid borrowers.
Under these circumstances, you may be better off going private for one or two years, giving you time to locate and secure a better commercial financing deal where you’re getting full lending value for your real estate.
In the short term, if the private lending rate is comparable to the institutional rate, you’re not really losing anything on cost, and on cash flow you’re likely paying interest only to service the debt which makes more cash available for other things.
Many times private commercial mortgages can be arranged with no prepayment penalty after a certain number of months, so when you finally have the bank or institutional deal you’re looking for, you can pay out the private lender at any time.
This strategy has the potential to create a significant cost saving to you in the long term, especially when you’re talking about higher leverage and interest rate differences of 0.5% or higher over time.
What I’m about to say may sound counter intuitive, but bear with me for a moment.
When a business is being acquired or a business is purchasing assets from another business, the one main deal killer is getting the amount of required financing in place in a defined period of time.
And because many times the deal cannot or even will not be completed by the purchaser without sufficient leverage being in place, it can be hard to get deals done, especially if the amount of leverage required is considerable.
Even if you know you are strong enough financially to qualify for the required amount of business financing, the process for getting the financing can take longer than you have, especially when dealing with a bank or institutional lender.
So what can you do to avoid this problem or at least reduce the chances of it being a factor?
Choose another approach to financing.
This can involve leveraging other assets you may own that are free and clear, going to an asset based lender who has a faster application and assessment process, putting more short term cash into the deal, and so on.
The point here is that there are ways to get money in place faster than perhaps the ideal financing structure.
But once the deal is closed, you can spend whatever time is necessary to arrange a better financing set up.
Will this type of approach cost more money?
Well, potentially yes, but it depends on how you’re adding up the cost and building them into your decision making.
An asset based lending approach for instance is going to be more expensive than a bank or institutional credit facility, but if you can’t close the deal, what good is the cheaper money to you and how much opportunity cost have you lost by not moving forward.
The key here is that you’re confident in your ability to secure the right type of financing sooner than later, so the costs of taking a faster approach to closing are ones that should be factored into the initial purchasing decision.
If you buy into the argument that business financing is going to be difficult for anyone to arrange for the deal, and that its unlikely what you’re trying to acquire will be purchased for cash, then why not discount your offer to purchase to reflect the costs associated with a faster close financing strategy?
By being more creative in terms of how you price the opportunity and get the deal closed, you are putting yourself in an enviable position in the market to land great deals and avoid the frustrations of your competitors who take the traditional (but may times flawed and ineffective) approach to business financing.
In a business acquisition scenario, if you can get through the business ownership transition process quickly without negatively impacting the bottom line, you may actually be able to secure a better long term financing deal after the fact as the transition risk from the sale has been removed from the lender’s list of things to be worried about.
This approach isn’t always going to work, but if you have cash and other assets to play with, and are confident in your ability to generate positive results from your capital investments, then faster close strategies are something to think about.
Ontario asset based lenders lead the Canadian market in terms of coverage of the market place.
Because of the size of the Ontario market compared to other areas of the country, asset based lending in Ontario can function in a relatively small geographic area which is very appealing to asset based lenders who typically require regular monitoring of accounts.
The term asset based lending can mean a number of different things, but for the most part its about lending against the market value of assets that a specific lender knows how to liquidate in the even of default.
Asset based financing is by definition higher risk lending because more of the lending decision is based on the security value of the asset as compared to bank or institutional lenders that require lower levels of overall balance sheet leverage in order to justify a loan request.
With an asset based lender, the lending decision is more about the difference between the immediate liquidation value of assets and the amount of financing they provide. As a result, it is much more formulaic than conventional bank lending.
That being said, a growing area of larger Ontario Asset Based Lending is in the bank’s own specialized niche for asset based loans.
In this particular space in the market, larger banks are providing higher amounts of leverage to clients that are in the lower risk range of the asset based lending world. These are typically asset based loans for $5.0 M plus, so are only available to a small percentage of the market.
For the majority of small business and medium sized businesses in Toronto and the Greater Toronto Area, there are a considerable number of different asset based financing options where either one type of asset is the focus such as a pure accounts receivable factoring house, or a number of assets can be considered collectively.
Each model typically has its own unique fit into the market and financing costs and structure.
The challenge for a business owner, especially for one that has a variety of assets that can be financed through asset based lending, is picking the right model.
In some situations, using more than one asset based lender can be preferred in order to obtain both maximum leverage and a lower cost of financing.
But more lenders involved can also lead to more deal complexity and greater administration requirements to meet the needs of all parties involved.
The best way to approach this area of the market is to work with a business financing specialist that works in the market and has direct experience with a variety of Ontario Asset Based Lenders
I came across a number of articles today on Canadian interest rates and projections for where they are going and like usual, the prognosticators are all over the map.
But this time at least, I believe its for good reason.
The governor of the Bank of Canada uses interest rates like a gas peddle to manage inflation in the economy. Inflation becomes an issue with the actual production capacity of the country starts to reach the production potential. As production potential is reached, inflation can start to build quickly.
Over the last 6 months, Canada has seen a higher than expected level of growth, narrowing the gap between actual and potential production capacity with experts now saying that capacity could be hit in 2012.
Because it can take a while for the brakes to come on with interest rate moves, it would seem that larger interest rate increases are coming and may need to happen more often which will directly impact your business financing plans going forward.
But then, there’s the other side of the coin.
The recent spike in the value of the Loonie against USD is likely going to slow down economic growth as exports start getting too pricing. And if the Loonie stays above the U.S. dollar for an extended period of time, the economy could very well slow down on its own.
And if you prematurely increase the interest rates, the Loonie could go even higher has holders will be getting a higher return for their money creating increased demand.
For more background on this topic, here is pretty good article you can refer to… http://www.theglobeandmail.com/report-on-business/economy/loonie-could-slow-growth-for-years-bank-of-canada-warns-in-report/article1983484/?utm_medium=Feeds%3A%20RSS%2FAtom&utm_source=Report%20On%20Business&utm_content=1983484
So with all that being said, what is going to happen?
If you leave interest rate increases too long, there may not be enough time to react and you run into inflationary impacts.
If you increase interest rates too soon you could help stall out the economy due to the likelihood that the Loonie is going to stay at a high level for a while, potentially even years.
Because of where we are at right now, its almost a given that interest rates are going up. Inflation can become a run away train that creates the next recession sooner than later, and the Bank of Canada is going to do everything in its power to not let that happen
The questions that remain are how much and how often?
Right now, the experts are calling for modest increases in July.
That could hold.
But an increase could also be sooner and higher than expected as well.
Your guess is as good as anyone’s at this point.
One of the logical conclusion business owners have drawn in the last couple years during which cash flow has been tight for many is that they should be able to refinance the equity in their equipment to inject capital back into the cash flow.
In many cases, more established businesses with long life use assets have paid off any loans or leases owing and hold clear title to the equipment.
But while this is logical to the business owner, its not so automatic with financing providers.
The key to this type of financing is the same as any type of financing, and that’s cash flow.
If the financing is required to prop up cash flow, then there are going to be less interested parties to provide the required debt financing and those that are interested are going to charge more for the associated risk.
As a result, refinancing equipment is not an easy game at all, especially in Canada with U.S. lenders being more open to the idea.
For the small to medium sized business owner, the challenges start with amount of financing versus security value.
To start with, most debt financing sources that will provide equipment loans and leases to refinance existing equipment will not fund more than 40% to 60% of the forced liquidation value of the assets in question.
When you’re in a depressed market period where the used equipment market is flooded with inventory, the forced liquidation value may only be 50% or less of what the business owner believes is the long run fair market value.
So if I believe my equipment is worth $100,000 and the forced liquidation value is 50% of that, and the lender will only lend 50% of forced liquidation, I’m now looking at potentially securing $25,000 against assets owned free and clear.
But for these smaller amounts of financing, the only lenders that tend to consider these applications are ones that can be convinced that better days are ahead and that the business is either stable or in a growth position versus being in distress.
With larger financing requests of $250,000 or more, the refinancing can still be done through an asset based lender even if the business is in a distressed situation, but the rates and fees are going to be substantially higher due to the higher risk of business failure and loan loss.
So if you’re looking at your equipment as a source of additional capital, consider what you might be able to actually get out of it as well as the cost of financing.
Another challenge is to figure out who is most likely to be able to help you and for the better rates and terms.
For my two cents, I recommend you work with a business financing specialist who can help you quickly determine what’s possible and where to apply so no time or money is wasted going through the process.