Investigating the types of finance companies and types of leases
Whether you are starting a business or have an established one, you will at one time or another work with a finance company. Finance companies are labeled by the way they are structured. This structure can make a difference on the advantages and disadvantages that they offer your business.
Here are the different finance company structures:
1.Bank Affiliated – This finance company frequently can provide very competitive interest rates. They are also good for relationships – especially if it’s your bank and you have open credit availability. You may not want to choose this option if you are maxing on your conventional credit or it is a competing bank. Banks can be very territorial. For example it is not a good idea to choose a Chicago-based finance company if you are buying equipment for your “Dallas” operation. Many banks may be limited to do business in the state where they are located.
2.Independent – An independent finance company has the greatest flexibility, will finance almost any type of equipment, and can offer very competitive rates although not usually as low as the banks or the captives (equipment suppliers).
3.Brokers – This is generally considered the most expensive form of leasing as they typically turn a transaction around and sell it to an independent leasing company or bank affiliated company. They may need to get the third party’s approval in order to get the transaction completed. They can typically get “bruised” credits approved through higher risk sources.
4.Captive – These are owned by the equipment suppliers and can provide very low rates because of their familiarity with the product. They also may use a lease as a “loss lead” to move equipment. They typically can only finance their products and will not lease products from multiple manufacturers. Some independent leasing companies may become a manufacturer’s “captive” finance company when the manufacturer buys down the rate, making it cheaper for the end customer.
Since leasing is considered a viable option for equipment financing, let’s also review the types of leases:
Operating Lease – This is the typical “Off Balance Sheet” type of lease. It is typically a shorter-term lease and frequently is on equipment where there is a high likelihood of it being raised when the lease ends, such as high-tech equipment, computers, or high-usage copiers. It answers 4 criteria as established by the Financial Accounting Standards Board (FASB):
1) Ownership of the property does not automatically transfer to the lessee at the end of the lease term.
2) The lease does not contain a bargain purchase option.
3) The lease term is less then 75% of the useful life of the equipment.
4) The present value of the lease payment is equal to less then 90% of the cost of the equipment.
Under this scenario, the payments are an expense and no asset or liability is recorded on the balance sheet. The accounting profession is playing with these standards; within the next 5 years there may be no off balance sheet transactions. If your lease meets these standards, then the payment can be expensed. Although if your financial statements are not audited, the IRS has a looser definition of what constitutes an operation lease. Typically they will allow this treatment for any lease with at least a 10% purchase option.
Capital Lease – This is also typically called a finance lease. It is an asset and liability issue and the lease typically has a bargain purchase option of $1.00. Companies who use this type of lease will do so for a variety of reasons of which we have covered earlier, primarily for cash flow management, flexibility, fixed payments, and tax deductibility.
Sale/Leaseback – This is a situation where a company has purchased and is using the equipment, which they then sell to a leasing company, who in turn charges rent for the usage. The main reason for doing a sale/leaseback is so that a company, which has recently paid cash for a piece of equipment, realizes that they could have put the cash to better use.
Trac Lease – This is for vehicles only. In this lease, the lessee guarantees the lessor they will not suffer a loss on the residual buyout at the end of the lease. Typically these types of leases are done with semi-tractors and trailers.
In the end, you will want to seek out and talk to several different sources before you decide on a finance company that you will want to work for now and in the future. Many companies choose a lease/finance company because they may have the cheapest rate. Sometimes rates may not be the most important factor, it could be flexibility, ease of working with the finance company, or a company’s willingness to work with you in the future. Whatever you decide, make sure you feel comfortable with the people that you are working with, because in the end, they will be the ones that will be able to help with your company’s future expansion plans.
In your search, consider Advantage Equipment Leasing for your finance company. We are based in Milwaukee, Wisconsin and serve clients nationwide.
Contact us online or call us at 800.949.7040.