Equipment leasing is a time-honored financial tool used by many companies to finance all types of new and used equipment. Despite broad applicability, there is a group that historically makes surprisingly little use of equipment leasing: private equity portfolio companies.
Recently, however, the number of equipment finance deals by private-equity backed businesses has ticked up. One reason for this is a slowdown in merger and acquisition activity, which gives private equity firms more time to focus on transactions within their portfolio companies to optimise performance. Aside from time constraints, one reason why private equity companies don’t turn to equipment financing more often is that firms typically set up a senior credit facility at the time of purchase and use this for all their financing needs. Another reason is that they don't realise the full extent to which leasing may lower their cost of capital.
So why should private equity-backed companies make more use of equipment financing? First and foremost is simplicity. An equipment lease is a standalone transaction that typically does not require the company to amend the senior credit facility or get approval from the bank group that funded the acquisition. This can be an important source of liquidity for the management team as it tries to build the business.
Other benefits include accounting flexibility and leverage advantages. Leases can be structured as capital on-balance sheet or operating off-balance sheet under Generally Accepted Accounting Principles.
While the simplicity, accounting and leverage advantages are particularly relevant for portfolio companies, equipment financing offers additional benefits worth considering.
If the lessee cannot make full use of the accelerated depreciation deductions available to owners of equipment in the U.S., a true lease may be the best option. In a true lease the lessor is the owner for federal income tax purposes and retains the benefits of accelerated depreciation. The lessor can use these tax benefits to structure a lease with lower rental payments.
Financing equipment also preserves internal cash that can be used for higher-yielding investments and emergencies. Additionally, leases are a form of fixed-rate long-term financing, which is usually a more optimal way to finance long-term assets than the short-term revolving credit facility.
Lessors often calculate that equipment will have some residual resale value at the end of a lease and will share this value with the lessee in the form of reduced lease payments. For this reason, lease payments are usually less than debt financing payments saving cash.
Certain assets are either very expensive to maintain or become obsolete in a relatively short time. By cycling out of these assets periodically before maintenance costs begin to mount, companies save repair and downtime costs, boosting revenue and valuations. Also, leasing can provide flexibility to meet strategic needs. Equipment assets are sometimes tied to specific projects or contracts. By matching the lease term to the project or contract term, companies can “walk away” from the equipment once the project is completed or contract ends.
Sale-leasebacks of equipment, in which a company sells an asset to a financial institution and then leases it back, generates cash and improves liquidity. This provides the company with additional cash and preserves available bank lines.
Equipment financing and leasing is a way to have the best of both worlds: hold onto more cash than is possible with an outright purchase of new equipment, but enjoy the revenue and productivity benefits of using new equipment. For private equity portfolio companies, leasing can play an important role in improving the performance and valuation of portfolio companies. Done with the right financial partner, equipment leasing can help the company grow and help the private equity partners boost valuations.
Eric Dusch is chief commercial officer, Equipment Finance at GE Capital, Corporate Finance.