How to pay for that new machine tool: innovative approaches to funding help shops and plants acquire the technology they need

In recent years, many machine shops have experienced a significant decline in sales; compression of margins; increased competition; exportation of machining and manufacturing demand; difficulty in obtaining working capital and acquisition financing resulting in operating losses; and an erosion in tangible net worth. Those shops that have remained profitable and experienced upward trends have several common characteristics: experienced and disciplined management, a diverse customer base, no significant customer concentrations, proper leverage and stringent cash flow management.

A challenge all equipment buyers experience is determining the best means to fund an equipment acquisition: cash/equity, a bank revolving line of credit or an equipment loan. Equipment financing is especially difficult during lean economic periods, when a prudent businessperson needs to monitor and forecast cash flow needs and availability to remain solvent.

All three acquisition payment methods entail both advantages and disadvantages. Cash purchasing is simple, requires no third party intervention and alleviates a buyer from future debt/rental payments--yet a cash purchase may adversely affect a company's solvency. Using a bank working line of credit availability is another simple funding method that requires no third party intervention. The bank line of credit financing method typically offers a competitive, variable rate loan, yet it may adversely affect a company's access to business flow interruptions and impact daily working capital requirements. Leasing has become the most common method of funding equipment needs

The Changing Equipment Finance Marketplace

The equipment finance marketplace has changed considerably in the last decade. As a result of consolidation, industry specialization and contraction of capital markets, machine tool buyers are left with fewer options to find financing sources in the traditional bank and finance marketplace. This has led to the growth of captive finance companies owned and operated by either a manufacturer or a distributor. Captive vendor finance companies provide finance products and services exclusively to their parent companies' customers. Most progressive manufacturers and some of the more prosperous distributors are providing equipment financing as an extension of their selling services in order to promote acquisition.

Captive vendor finance companies provide convenient, creative and alternative finance solutions to equipment buyers. These companies offer distinct advantages over banks, finance companies and brokers. They have an understanding of the industry and equipment, the intended use of the equipment, customer credit profiles and the specific customer equipment applications. Furthermore, captives are able to offer a variety or finance products tailored to meet specific customer needs.

Reviewing Options

Many different finance options are now available. These include a loan, capitol lease, finance lease, operating lease, off-balance sheet lease, tax lease, non-tax lease, promissory note/security agreement, skip payments, step-up or step-down payments, and many others. The variety or product options can often be confusing. To simplify the process, buyers should consider two financial concerns prior to selecting a finance product--tax appetite (the need for depreciation deductions to reduce actual tax paid) and cash flow.

If the buyer seeks the depreciation benefits of ownership, a non-tax lease, lease purchase, finance lease, loan or capital lease may be the product needed. Conversely, if the buyer has no tax appetite, prior or current losses, restrictive loan covenants regarding increased borrowing/leverage, or need for short-term utilization, then a tax lease, operating lease or off-balance sheet lease may be the product needed.

Once the lease product has been identified, the term and payment structure can be developed to meet the borrower's cash flow needs. Other features of the lease such as rate, down payments, balloon payments, deferrals, commencement terms, prepayment penalties and guarantees are then typically negotiated based on the customer's credit strength and specific needs.