Dan Furman Dan Furman
VP of Strategy

Best Practices for Financing and Leasing in 2023

January 30, 2023
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section-179-equipment-leasingInterest rates, inflation and recession remain top of mind for business leaders as we head into 2023. Here we share some best practices for financing and leasing equipment in such a business climate. Businesses use credit for several reasons, including for financing equipment purchases, and because companies need machinery, vehicles, and other equipment to stay competitive, getting the best overall value on their financing deals makes a lot of sense.

At the same time, we’re also mired in an interesting if not challenging economy. Everything costs more, supply chains and labor remain strained while demand is high, and rates continue to climb. All of this has company leaders full of questions regarding financing and leasing. 

How high will interest rates go is a key question on everyone’s mind. The Federal Reserve spent 2022 raising rates to combat inflation, including several concurrent 75 basis-point increases, a historic first. But inflation remains stubborn, and while the Federal Reserve has signaled it may be finished with 75 basis-point increases for the time being, it remains worried about inflation with no plans in sight to end rate increases.   

Most economists predict that rates will continue to rise in 2023, and even when they stop rising will likely hold fast until inflation is vanquished.

Some Straightforward Best Practices

Since our higher-rate environment likely will continue, let’s discuss a few key factors that can help companies looking to borrow. These straightforward best practices can save headaches moving forward.  

  • Best Practice: Don’t try to wait-out rates. 

For businesses, the current climate is not advantageous to “waiting out” rates. which likely will to continue rise, followed by a sustained period where they will level off and hold fast. If a company needs to replace or upgrade equipment or expand to meet increasing demand, waiting likely will ensure that they pay an even higher rate later. Waiting also can open the door for competitors to pass them by. 

Quick anecdote: the natural reaction to rising rates is to hold fast. A client of ours almost backed out of a deal in March 2022 after missing the first increase, feeling like it lost out by not financing sooner. But they needed the equipment, so after some internal discussion they went ahead. Many increases later, they are sitting pretty with their rate locked in.

  • Best Practice: Choose the right loan or lease structure.

For purposes of this discussion, let’s compare an EFA (equipment-financing agreement) to an operating lease. For most small to midsized companies, a fixed-rate EFA makes the most sense. This essentially is a traditional loan with a fixed term and fixed rate so that monthly payments do not change.  Note: Always insist on a fixed rate.

With an EFA, the equipment is owned (e.g., on the balance sheet) and, most importantly, allows a company to take a full Section 179 deduction--very desirable to most companies. However, some companies may prefer an operating lease, where the equipment is not on the balance sheet and a Section 179 deduction cannot be taken. Three cases where a company amay select this option: It’s a public company and new asset purchases require board approval, which may not be timely; they want to make the balance sheet more attractive to investors; or they want to keep debt-to-equity ratios low to prevent breaking bank covenants. 

  • Best Practice: Be aware of loan covenants and restrictions.

Many lenders, including most banks, will impose several covenants and restrictions when lending to businesses. Companies should be aware of these before entering into a finance or lease contract. These covenants will include a blanket lien, which puts a lien on all company assets--even future assets. Other restrictions include minimum bank balances and having to requalify for the loan annually--this is where the previously mentioned debt-to-equity ratio comes in. If any of these are broken, the lender can immediately call in the entire loan.

These restrictions have become increasingly common as borrowers look for the lowest rate (more restrictions = a lender can offer a better rate.) Many companies enter loan contracts unaware of these fine-print restrictions and are surprised later when they cannot sell an unrelated piece of equipment (blanket lien) or acquire a new piece of machinery (too much debt) without the lender’s permission, which may or may not be granted.

Before agreeing to any financing or lease contract, be aware of all covenants and restrictions and ensure that they are clearly understood and acceptable. Even in a higher-rate environment, many companies would prefer paying an extra point of interest if it means keeping full control over their assets and capital. MF

Industry-Related Terms: Point
View Glossary of Metalforming Terms

 

See also: Crest Capital

Technologies: Management

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