Put it on Plastic
For many manufacturers, leasing is a good idea
By Robert B. Aronson
These days, less than 50% of machine-tool purchases are cash deals: the rest use some form of financing. In selecting a financing source, buyers will deal with the institution that gives them access to low-cost funding or has a link with a manufacturer or point-of-sale that can provide special services.
Now seems to be a good time to finance. Lenders do not regard lending for machine-tool purchases in the same way they do less-stable business, such as real estate. Plus, manufacturers generally have good records of payback, and the machine tool is a very saleable asset should the customer default.
Currently, leasing seems to be the favored financing method, because it offers the benefit of low initial cost. The customer therefore has more cash available to handle other investments or unexpected costs. This is particularly advantageous for startup companies.
Financing is usually obtained through one of these agencies:
A broker. Brokers are agencies that can range from a one-person office to a major institution and deals can range from a few thousand to millions. Brokers act as a bridge between the borrower and the source of funding. They generally work with smaller operations, and handle many low-end loans. According Beverly Anderson, president, Fidelity Leasing (Las Vegas, NV): "A broker has various credit windows with different lenders. We can finance $5000–$20 million, and generally work with both vendors and potential lessees when setting up a deal. Our success is based on our ability to determine what lender best fits the client's credit profile, as well as being set up as a broker with a wide range of lenders. Most of our business comes from vendor or client referrals."
Banks. Local banks are the institutions the machine-tool buyer normally deals with, and are often where the financing search begins. The advantage to the manufacturer is that the bank knows the company asking for the loan, the value of collateral equipment, and the borrower's financial condition.
Larger banks get a greater share of the business, and may have financing divisions dedicated solely to working with equipment buyers. For example, US Bank Corp. (Minneapolis, MN), the nation's sixth-largest bank, has had a division devoted entirely to machine tool financing for the last 25 years. It is the nation's largest bankowned leasing company. The main difference between the US Bank machine tool financing operation and a broker is that the former has the assets of a major bank available to it. "Because of our link, we usually can offer better rates than a broker," explains William Moore, US Bancorp, Machine Tool Finance Group. "We find that brokers set up deals with a value around $50,000, and often work with companies that have a credit problem," he says. "They shop around for the best deal among various lenders. Our largest competitors are the local banks, but they generally have a load limit around $80,000.
"For loans of $300,000 and up, banks get scared because they don't know the industry. We, on the other hand, know the machine tool industry and have a huge presence," Moore states.
For large loans, say $30 million, US Bank may split the loan into increments of $10 million, and arrange the deal among other financing agencies. This way the risk is mitigated. But the deal is invisible to the customer, who deals only with US Bank.
On the other side of the market, US Bank often works with small startup companies with a good personal finance history. They may finance 80–90% of the start-up's machine-tool purchase costs.
"Our strength is we don't just pay off the vendors and collect payments," Moore continues. "We establish lease and loan types as well as payback amounts and durations, and monitor delivery times."
As a general rule, if a new customer's company has been in business for three years or more, US Bank may offer deals up to $300,000. For existing customers with a record of at least 18 months of prompt payments, they will approve financing to $500,000 with minimal paper work. "But," notes Moore, "we have to know the industry and its products to do that safely."
US Bank works with everyone from companies that have zero sales through Fortune 500 companies with sales in the billions.
Executives of National Penn Bank (Boyertown, PA) decided to start a Manufacturing Lending Group in 1999. The initial goal was to take advantage of the intensive manufacturing activity in southeastern Pennsylvania.
Among the pre-launch programs was an extensive survey of the industries they wanted to work with. From this information came their decision to focus on privately held companies that grossed less than $50 million annually.
The first step in serving that market was to make sure the lenders were well trained and aware of manufacturing issues. So National Penn required that all Manufacturing Group lenders had to complete a course in lean manufacturing. "We wanted to make our staff knowledgeable about the needs of their clients, so that they could speak their language," says Scott L. Gruber, National Penn executive vice president, who was head of the Manufacturing Group before assuming his present role in the company. The training was also designed to help the Manufacturing Group bankers dispel the myth of the cold banker who imposes immediate penalties for missed payments.
"When we began working with clients, we wanted them to understand that we are a resource, not a decision maker, for them," says Gruber. "But we can help them evaluate what to do. For example, if our analysis finds that an overseas link is advisable, we help them find a partner overseas."
Another important decision is whether the clients wants a short-term contract of something more flexible. The first case involves a specific number of parts produced over a given time. The other type may eventually include more foreign-made products or, if the US manufacturer finds a potentially profitable niche, expansion into the overseas market.
The client's products and production methods play a big part in any decision. For example, if the client makes a product that involves expensive materials and high-precision machining, bank research may indicate that the job might best stay in the US.
Resources available also include a group of international advisors who can competently evaluate a given situation for the overseas point of view. Attorneys in this group have overseas offices and can help sort out the legalities involved. Of particular benefit is advice about Chinese manufacturers, who may operate under a number of regional laws.
To keep the bank on track with both foreign and domestic manufacturing issues, the Manufacturing Group turns to a number of regional manufacturers who serve as a board of advisors. "They keep us informed on what keeps manufacturers up at night," says Gruber.
Another group of experienced manufacturers is available to consult with the client during the course of the relationship with National Penn.
Vendors. A few major companies have their own "captive financing" divisions. They may offer a turnkey service, or work only with the equipment made by a given company. The captive finance company for Haas Automation Inc, (Oxnard, CA) finances the purchase of that company's machines. "Currently business is good," says the Haas finance manager, Justin Snyder. "The economic problems facing other industries, principally housing, have not affected the lenders' appetite for machine tool financing. This due to the fact that customers are paying well and the resale values of the machines are high, so the collateral is very attractive."
One reason Haas started a financing operation was to help people with finance problems purchase their equipment. Once established, customers tend to stay with Haas. "We try to work with our customers and have a softer approach to credit problems, where a bank is more difficult to negotiate with," Snyder explains.
"We are known as an accommodating lender. Our goal is to put people into business, not just collect a fee. If you can prove you are a going concern, we might lend you money. We work a lot with new ventures, some that consist of little more than someone with a good idea," he concludes.
Currently about half of Haas customers are paying cash or starting with a large down payment. The rest will be dealing with the finance division.
Makino, Mazak, Haas, and Mitsubishi have finance divisions that only serve the companies' customers, using funds provided by the machine builders. These companies have financing resources of their own, with a separate "captive finance company." The captive handles all aspects of a deal. There are no third parties. They sell, make credit decisions, and arrange terms, functioning, rather like GMAC (General Motors Acceptance Corp.).
"Among the benefits we offer is our knowledge of both the machinery and what the user wants to do with it," says Christopher Lyle, customer finance manager, Makino Inc. (Mason, OH). "We want the deal to stay with us, so we can offer unique services to the buyer. A big benefit we offer is that we often are not as strict as a bank if a default occurs. For example, we may take a machine back, rather than forcing bankruptcy. This may allow a customer to stay in business, and possibly return when conditions improve. We often handle turnkey jobs that may include equipment Makino doesn't make. We blend all the orders so the buyer deals only with us."
This division has been growing at a 40% rate per year, chiefly because of increased sales of new equipment. The increase, in turn, is driven by a combination of machines wearing out and customers wanting more advanced machines.
At Makino, about 30% of the sales are financed through the customer's local bank, 30% arrange a deal through the equipment supplier, 30% use brokers and 10% pay cash.
Some of the larger machine tool companies offer financing options that parallel those of the captive financial institutions. For example, Agie Charemilles (Lincolnshire, IL) has a good relationship with US Bank Corp. "With this arrangement Charmilles has more opportunity to 'bend the rules' to help customers with a credit problem, particularly those customers with whom we already have a relationship. This service is not available elsewhere, and it includes various incentives, such as offering more money toward the purchase," says Gisbert Ledvon of Agie Charmilles.
"We see a stronger trend toward paying cash, but 30–40% of our customers will finance," he observes. Some opt for a rental agreement, which is attractive when customers are not sure they will need a certain machine in a year or two. Or sometimes they find the new machine does not fit their needs. "After about 18 months, we usually find they either return the machine or buy it," says Ledvon. "But both renters and lease holders usually end up buying the machine."
Bad credit does not have the same stigma in machine-tool purchase negotiations as it does in personal finance. "We find that customers will pay their debts," he concludes.
A fairly new financing arrangement has been introduced by some of the larger distributors. They function as brokers, and have the advantage of a close relationship with customers. The borrowing deals may be arranged the same way a broker operates—contacting funding sources and obtaining the best deal.
What's Good About Leases
There are a number of advantages claimed for leasing a machine tool, rather than buying it. According to Beverly Anderson, president, Fidelity Leasing (Las Vegas, NV), the list includes:
Up to 100% financing. This includes freight and installation.
Conserve credit and capital. Leasing lets you preserve your established bank lines and conserve cash reserves. It enhances your borrowing capability, and may improve your balance sheet by reducing long-term debt. Leasing does not demand the large up-front cash outlay required by most banks.
Flexible payment plan. Payments are arranged to match your budget, seasonal business, or earnings that will be generated by the leased equipment.
Hedge against obsolescence. Because monthly payments are a small portion of the total cost of the equipment, you have the freedom to purchase new equipment quickly and cost-efficiently, without the burden of obsolete equipment.
Overcomes budget limitations. Leasing allows you to obtain new equipment when budget restrictions prevent direct purchase.
Choose the equipment you want. You make all the arrangements as to price and specifications directly with suppliers or manufacturers. Plus, you are certain all of the warranties.
Fixed monthly payments. Leasing takes the guesswork out of budgeting because you have a fixed payment over a fixed period of time, and there are no varying costs to be estimated.
What Financing Is Available?
There are many ways to structure deals for customers. Here are the two major lease options offered by US Bank:
Capital lease or loan. In these transactions, the debtor takes possession of the financed asset at the end of a contract. The arrangement is much like any other direct loan. You get a certain amount from the bank, and pay it back in fixed amounts over a given time period. Some manufacturers like to work with local banks, because of an established relationship.
With this type of financing, the asset is recorded on the asset side, and the amount owed is recorded on the liability side. The machine is usually depreciated over seven years, and that amount is expensed on the income statement. The deal can be set up with balloon payments or purchase options at the end of the contract. For example, the borrower may keep the asset for a payment such as 10 or 15% of the original purchase price. Many times it's just $1.00. The term typically is 24–84 months.
Rental. This arrangement is also called a true lease or operating lease. At the end of the lease term, the customer can return the equipment, buy it for fair market value, or continue to rent. This arrangement does not show up on the debtor's balance sheet, and the payment is expensed on the income statement as machine rent. In most cases, the lender takes the depreciation.
True leases or rentals allow the customer to return the equipment, buy for fair market value, or continue to rent. This does not show up on the debtor's balance sheet, and the payment is expensed in the income statement as machine rent. In most cases the lender takes the depreciation. The term typically is 12–84 months.
This article was first published in the March 2008 edition of Manufacturing Engineering magazine.