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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 type of alternative financing facility.
For various economic and financial reporting considerations, this finance strategy continues to be scrutinized as a financial option for Canadian business. Let's dig in.
WHAT IS A SALE AND LEASEBACK?
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 ' lessor ' ,as it pertains to equipment, or a mortgage firm of some type if it pertains to real estate,( sale lease-back commercial real estate ) such as owner owned premises. At the time you negotiate such financing you have the ability to 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 '.
SHOULD YOU CONSIDER A SALE LEASE BACK
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 the debt to equity ratio of a company.
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 teh transaction. The process can sometimes be confusing to owners as it is really a combination of sorts of both debt and equity financing by virtue of the cash received.
EXAMPLE OF AN EQUIPMENT SALE LEASEBACK DEAL
Let us assume a transportation/trucking firm has a significant investment in its truck fleet. At the start of the transaction, the trucks are unencumbered with liens by virtues of the ownership of the assets. 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 typically used for any general corporate purpose, for which there might be a number of 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 be able to prove proof of ownership of the asset or assets in question and its 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.
KEY BENEFITS OF A LEASEBACK TRANSACTION
1. This is an accepted way of raising capital that has a couple key benefits :
2. The company has the right to still use the asset for its original purpose
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 potential requirement of the firm 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 though 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 '
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 '
The overall sale leaseback 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, as well as, 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 - 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 value
3. The ability of the borrower 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 very basic - 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 asset back from the finance firm.
There are of course some key accounting issues that Canadian business owners and financial managers have to take into consideration. Based on the value of the transaction 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, and balance sheet, and income statement enhancement.
If your firm structures the transaction as a true operating lease when you enter into the sale leaseback you have somewhat magically taken debt off your balance sheet and improved many of your key operating and loan covenants.
Payments create a monthly expense and this amount more often than not 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 strategy of a sale leaseback 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. ( A higher purchase option has the effect of lowering the monthly payment on a financing lease transaction.
POTENTIAL DISADVANTAGES OF A LEASEBACK FINANCE
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 non-ownership of the asset - 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 ( example - real estate ) or alternatively they are revenue and profit-producing assets of the business.
Assets that aren't critical to the use of the business are often simply sold and deemed as not being core to the operations of a company. But the refinancing process we have outlined releases equity in assets you own and can provide valuable working capital at a time when it is really needed.
CONCLUSION
Companies have the ability to consider numerous benefits of the sale leaseback 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, as well of course as utilizing the cash to grow sales revenues, clean up the balance sheet and reduce other more expensive debt.
Seek out and speak to a trusted, credible, and experienced Canadian Business Financing advisor to ensure you are working with the right sale lease-back companies.
7 Park Avenue Financial :
South Sheridan Executive Centre
2910 South Sheridan Way
Suite 301
Oakville, Ontario
L6J 7J8
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7 Park Avenue Financial provides value-added financing consultation for small and medium-sized businesses in the areas of cash flow, working capital, and debt financing.
Business financing for Canadian firms, specializing in working capital, cash flow, asset based financing, Equipment Leasing, franchise finance and Cdn. Tax Credit Finance. Founded 2004 - Completed in excess of 100 Million $ of financing for Canadian corporations.
Stan has had a successful career with some of the world’s largest and most successful corporations. He is an experienced
business financing consultant
.Prior to founding 7 Park Avenue Financial in 2004 his employers over the last 25 years were, ASHLAND OIL, ( 1977-1980) DIGITAL EQUIPMENT CORPORATION, ( 1980-1990) ) CABLE & WIRELESS PLC,( 1991 -1993) ) AND HEWLETT PACKARD ( 1994-2004 ) He is an expert in Canadian Business Financing.
Stan has over 40 years of business and financing experience. He has been recognized as a credit/financial executive for three of the largest technology companies in the world; Hewlett-Packard, Digital Equipment and Cable & Wireless. Stan has had in-depth, hands-on experience in assessing and evaluating thousands of companies that are seeking financing and expansion. He has been instrumental in helping many companies progress through every phase of financing, mergers & acquisitions, sales and marketing and human resources. Stan has worked with startups and public corporations and has many times established the financial wherewithal of organizations before approving millions of dollars of financing facilities and instruments on behalf of his employers.
Click here for the business finance track record of 7 Park Avenue Financial
Stan Prokop
7 Park Avenue Financial/Copyright/2020
