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Alternative financing options for equipment purchases

Management | July 1, 2012 | By:

Friends, investors, vendors, finance companies and the U.S. government can all make good business partners.

Purchasing equipment is one of the most important tasks facing specialty fabric professionals. Obtaining financing, especially the right type of financing at an affordable cost, can be difficult—but it’s not impossible even in today’s economy.

For a specialty fabric products business owner thinking about financing new machinery or equipment, approaching investors to increase their interest in the business is a good first step. If the operation’s current investors appear reluctant to increase their equity investment, and if the business owner is unwilling to further dilute his or her ownership interest with additional equity investment, sticking close to home remains an excellent funding strategy. Friends, family, current investors and even the business’s principal shareholder/operator might be interested in—and benefit by—lending the funds to purchase needed equipment or machinery, rather than simply investing in the business. In addition to providing investors with more liquidity than an investment, a loan offers shareholders an opportunity to get money out of the business, a strategy that will become increasingly more important as the current low tax rates on capital gains increase or disappear altogether.

Hidden in plain sight

In addition to borrowing the funds necessary to purchase, upgrade and install machinery and equipment, another strategy could be a sale leaseback. This involves selling the assets of the specialty fabric products business—even equipment not yet purchased—and then leasing it from the new owners.

The new owners of the equipment (or the building housing the operation) can range from current shareholders, the business’s owner who hopes to improve cash flow until the business becomes profitable, or a third party interested in the tax breaks available to the “owner” of the equipment or business property.

Keep in mind, however, that a sale leaseback transaction has the potential to change “ownership” of the leased property, and thereby who is entitled to depreciation and other tax write-offs and benefits. Naturally, loans and sale-leaseback transactions must be at arm’s length in order to be accepted by the ever-vigilant Internal Revenue Service. Competent legal advice is almost always a necessity, adding to the initial cost of these close-to-home financing alternatives.

Vendor financing

While many sellers of so-called “big ticket” items offer leasing programs, in this troubled economy many suppliers have been as affected as their customers. However, an excellent funding source exists with finance companies that have ties to an equipment manufacturer, dealer or broker. For those with marginal credit, leasing brokers, who deal with multiple funding sources, can also help identify the best lender for your needs.

One important type of alternative financing is called “asset-based” lending. In general, commercial finance companies are often willing to lend to businesses that, for various reasons, cannot secure credit from a bank. The loan is secured by the assets of the business such as receivables, inventory and equipment and sometimes, real estate. Admittedly, although asset-based lenders usually advance capital more quickly and more readily than banks, they also charge more for the higher risks involved.

Bank financing

Yet another avenue to be explored, especially for conventional financing, is a bank—especially one that is familiar with the operation. Before approaching a bank, every business professional should have a general idea of the different types of loans available to better understand what the lender is offering, if anything.

One bank might offer a commercial loan to help the business purchase needed equipment with equal installments of principal and interest. At another bank, the same type of loan might be written with monthly interest payments and a balloon payment of the principal.

Pressured by banking regulators to build up their capital reserves, financial institutions (particularly larger banks) are also feeling pressure from lawmakers and the White House to lend more to small businesses to help the economy recover. A banker’s reluctance to lend and the need to improve its capital position might be satisfied with a U.S. Small Business Administration’s (SBA) loan guarantee.

Talk to your Uncle

Often thought of as a lender of last resort, the U.S. government is actually an excellent source for a variety of economical financing options. The federal government has a vested interest in encouraging the growth of small businesses. As a result, some loans, particularly those guaranteed by the Small Business Administration, have less stringent requirements for owner equity and collateral. In addition, many SBA loans are for smaller sums than most banks are willing to lend.

Even better, the American Recovery and Reinvestment Act of 2009 increased the maximum guarantee amount on SBA 7(a) loans to 90 percent, and borrower fees have temporarily been eliminated for the 7(a) program, as well as for both borrower and lender fees for 504 loans.

> The biggest and most popular SBA loan program is the 7(a) Loan Guarantee Program. The SBA guarantees up to $750,000 or 75 percent of the total amount, whichever is less. For loans of less than $100,000, the guarantee usually tops out at 80 percent of the total loan.

A 7(a) loan can be used for many business purposes, including the purchase of equipment, machinery, real estate, working capital and inventory. The loans can be paid back over as long as 25 years for real estate and 10 years for equipment and working capital. Interest rates are a maximum of 2.25 percent over the prime rate when the loan term is less than seven years, and 2.75 percent if more than seven years.

> At the top end of the SBA loan size spectrum is the CDC/504 Loan Program, which provides long-term, fixed-rate loans for financing fixed assets, usually real estate and equipment. These loans are usually made through Certified Development Companies (CDCs): nonprofit intermediaries that work with the SBA, banks and businesses looking for financing.

Fabricators and suppliers seeking funds of up to $750,000 to buy or renovate a building or buy major equipment bring the operation’s business plan and financial statements to a CDC. Typical percentages for this type of package are 50 percent financed by the bank, 40 percent by the CDC and 10 percent by the business or its owner.

In exchange for this below-market, fixed-rate financing, the SBA expects the business to create or retain jobs or to meet certain public policy goals such as an Enterprise/Empowerment Zone or a minority-owned business, for example.

The bottom lines

The lack of available capital continues to affect every specialty fabric professional, especially those seeking funding for new equipment. Massive demand for new money from capital markets is coming, and it is coming from all sides. In 2012, more than $860 billion of U.S. government bonds will reach maturity and require refinancing. Add to that an anticipated and still-growing federal deficit that will also need to be funded.

Despite these challenging conditions, however, businesses can avoid the credit crunch while side-stepping today’s spotty capital shortages with back-door or alternative financing. Financial flexibility is becoming as important as manufacturing innovation to secure long-term stability.

Marc Hequet is a business writer based in St. Paul, Minn.

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