Many business owners would likely agree that when it comes to investing in new equipment, there are countless hours that go into researching and shopping for the most suitable items, as well as considering whether the timing is right to make this type of investment. In general, acquiring new equipment — and this applies to a full range of industries, from manufacturing and construction all the way to medical and knowledge-based industries — can often be an effective way to boost productivity and increase capacity. At the same time, however, the financing aspect can present one of the biggest challenges for many business owners.
“Investing in new business equipment sends a very positive message to your customers — it shows you are willing to invest in improvements to better meet their needs, and it also demonstrates you have confidence in the long-term future of your business,” explains Bruce Pennington, Vice President, Equipment Finance, RBC Royal Bank. “But in addition to the equipment decision itself, it’s crucial for business owners to give just as much thought to the best option for how they’re going to pay for it.” This is where it becomes very important to understand how equipment leasing works and the benefits it may offer as an efficient and effective financing alternative that helps to preserve cash flow.
Dispelling common misconceptions
When hearing the word “lease,” many may tend to think of it more in the sense of leasing a car, where the lessee has to return the vehicle at the end of the lease, but that type of arrangement can be much different than an equipment lease. As David Magier, Managing Director, Equipment Finance and Leasing – Capital Markets and National Clients, RBC Royal Bank, explains, “For business owners, it’s important to recognize that leasing in the commercial space is much different than leasing a car; in a business environment, leasing can provide better cash flow and preservation of capital for more strategic business initiatives. It should be a key consideration in overall business planning.”
With most equipment leases, the company leasing the equipment (the lessee) typically has the same rights and obligations as an owner of the equipment would. They possess the equipment, maintain it and insure it. Additionally, the majority of lease financing structures are set up so that when the contracted payments are finished, the client owns the equipment. Many business owners misunderstand that if they lease the equipment, they will have to return it or pay an inflated value to purchase it at the end of the lease. This does not have to be the case if your lease is structured properly for equipment you know you wish to keep long term.
Among some business owners, there’s also uncertainty or misunderstanding about which asset classes can and should be considered for leasing. “Some business owners think leasing is available for certain types of equipment only, but it can actually apply to many different types of assets, including point of sale, IT systems, leasehold improvements, and even office furniture and fixtures in certain instances,” notes Pennington.
Cash flow management and other benefits
In equipping a business, one of the greatest benefits that leasing offers is the ability to help free up critical cash flow, as it enables business owners to access the equipment they need now, without tying up capital. When business owners opt to pay for equipment outright, doing so may restrict cash flow that could be better deployed to finance sales or to distribute to shareholders. Leasing, on the other hand, provides an opportunity to direct that working capital to where it may be more useful at the time. Additionally, by freeing up cash, leasing can also help business owners take advantage of growth opportunities.
With these benefits in mind, both Pennington and Magier emphasize that it’s worthwhile for business owners to consider leasing as part of their overall cash flow management strategy.
With flexible lease terms, purchase options, currency choices and payment schedules, leasing also adds an extra layer of flexibility, which can aid in meeting cash flow requirements.
“In some cases, there may also be the ability to match your lease payments to your cash inflows,” explains Pennington. “In addition, most lease payments can be expensed and leasing may help to mitigate certain tax consequences. Also, some business owners may be unaware that there is the ability to fund 100 percent of the purchase price, including the taxes.”
Understanding your options
Within the realm of equipment leasing, there is a range of options available. For example, business owners can choose fixed or variable interest rates, and the lease terms can be structured to fit your cash flow needs, both now and in the future. There are also lease lines of credit that may make managing multiple leases with varying terms easier for business owners.
Specifically in terms of structure, a variety of lease types and options exist. For example, a lease can be structured where the asset is leased for a set term and you buy it for a predetermined amount at the end. Or, you can lease an asset for a set term and then have the option at the end to return it to the lease finance provider (lessor). “The main thing to understand is that leases can offer flexibility to meet unique business owner needs and can be structured in many ways, depending on your goals and circumstances,” notes Magier. “We work with some of the largest companies in North America that leverage equipment lease structures as part of their capital procurement and management strategy. Many of them use leasing solutions even when they maintain substantial cash balances. Having finance solutions that fit into their equipment procurement process with consistent documents, terms and pricing are additional benefits for them. Leases can allow business owners to structure against the useful life of the equipment in comparison to a traditional bank or credit union term loan. If you’re buying equipment that has a market established 10-year useful life, then it can be structured that way to support your business’ cash flow.”
And Pennington reinforces the value of this type of flexibility in today’s business environment: “In business and in the marketplace, the introduction of risk continues to accelerate and the pace of change has accelerated. With leasing, which is probably the most flexible financing option available, options exist to give business owners the opportunity to refresh routinely, and to manage change and risks as they evolve.”
Taking the right steps when considering a lease
In determining whether leasing is an ideal option for your business, there are a number of important considerations to take into account, including:
- How long you will use the asset, whether it will quickly become obsolete, whether you prefer to upgrade every few years or if you wish to ensure ownership at the end
- Your cash flow situation and requirements
- Your company’s balance sheet presentation
- The current pace of change in business and technology
- The current stage of the business in its life cycle
Leasing and business owner planning
With statistics indicating that a large percentage of Canadian business owners will be exiting their businesses over the next decade, many may be considering either selling their business or transferring it to the next generation — as well as how to free up enough funds to carry them through retirement. In both of these scenarios, leasing may be a valuable option to examine and utilize.
For business owners planning to sell their business, balance sheet presentation is often reviewed in an effort to make the business look more attractive to potential buyers. As part of planning in this regard, there may be an opportunity to use leasing as part of the business’ capital structure for balance sheet purposes. One way this can be accomplished is through a sale-leaseback of assets. With a sale-leaseback, business owners can sell equipment they own outright (to a lessor) with a commitment from the lessor to immediately lease their equipment back to them. This type of arrangement unlocks the equity in those assets, freeing it up to be redeployed within the company and for purposes that may be strategically important.
This same approach may be useful in a situation where successors or the next generation will be coming in to take over the business. With a sale-leaseback arrangement, business owners get the freed-up equity, and can then decide how to take it out of the business to fund their retirement. This type of approach places some accountability on the next generation, as they must manage the business effectively to repay the lease.
“Before deciding to lease, it’s important to fully understand if, and how, a lease finance structure might benefit your company, so consulting with an expert should always be a first step,” notes Magier. “All financial circumstances need to be considered, and this is where a qualified equipment finance specialist plays a crucial role in working with the business owner, their management team and advisors so that everyone understands the options that are available.”
“At the end of the day,” Pennington emphasizes, “it’s about doing what’s best for the sustainability of the business. When it makes the most sense and when done properly, leasing can be a smart way to invest in the long-term competitiveness of your business.”
Upcoming legislative changes
Beginning in January 2019, there will be new lease accounting standards for public entities that have to report under the International Financial Reporting Standards (IFRS) and Financial Accounting Standards Board (FASB/US GAAP). In 2020, these new requirements will also apply to private businesses that report under these two standards. For Canadian businesses reporting under Accounting Standards for Private Enterprise, there are no planned changes at this stage.
Note: If you are a current business owner, to ensure your specific needs and circumstances are properly addressed and accounted for, it is crucial to engage qualified accounting and tax advisors in concert with your equipment finance specialists when considering potential lease structures for your business.
This communication is for informational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. The information contained herein, has been compiled from sources believed to be reliable, but no representation or warranty, express or implied, is made by RBC Royal Bank® or any of its businesses or representatives, as to its accuracy, completeness or correctness. To the full extent permitted by law, neither RBC Royal Bank nor any of its businesses or representatives, accepts any liability whatsoever arising from the use of this communication. This presentation is confidential and proprietary to RBC Royal Bank and may not be disclosed, reproduced, distributed or used for any other purpose by the recipient without our express written consent.
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