Every so often on this blog, we answer frequently asked questions about our most popular financing options so you can get a better understanding of the many solutions available to you and the benefits of each.
This month, we’re focusing on the sale-leaseback, which is a financing option many businesses may be interested in right now considering the current state of the economy.
What Is a Sale-Leaseback?
A sale-leaseback is a unique type of equipment financing. In a sale-leaseback, sometimes called a sale-and-leaseback, you can sell an asset you own to a leasing company or lender and then lease it back from them. This is how sale-leasebacks usually work in commercial real estate, where companies often use them to free up capital that’s tied up in a real estate investment.
In real estate sale-leasebacks, the financing partner usually creates a triple net lease (which is a lease that requires the tenant to pay property expenses) for the company that just sold the property. The financing partner becomes the landlord and collects rent payments from the former property owner, who is now the tenant.
However, equipment sale-leasebacks are more flexible. In an equipment sale-leaseback, you can pledge the asset as collateral and borrow the funds through a $1 buyout lease or equipment finance agreement. Depending on the type of transaction that fits your needs, the resulting lease could be an operating lease or a capital lease.
Although real estate companies frequently use sale-leasebacks, business owners in many other industries may not know about this financing option. However, you can do a sale-leaseback transaction with all sorts of assets, including commercial equipment like construction equipment, farm machinery, manufacturing and storage assets, energy solutions, and more.
Why Would I Want a Sale-Leaseback?
Why would you want to lease a piece of equipment you already own? The main reason is cash flow. When your company needs working capital right away, a sale-leaseback arrangement lets you get both the cash you need to operate and the equipment you need to get work done.
So, let’s say your company doesn’t have a line of credit (LOC), or you need more working capital than your LOC can provide. In that case, you can use a sale-leaseback to raise capital so you can kick off a new product line, buy out a partner, or get ready for the season in a seasonal business, among other reasons.
How Do Equipment Sale-Leasebacks Work?
There are lots of different ways to structure sale-leaseback deals. If you work with an independent financing partner, they should be able to create a solution that’s tailored to your business and helps you achieve your short-term and long-term goals.
After you sell the equipment to your financing partner, you’ll enter into a lease agreement and make payments for a time period (lease term) that you both agree on. At this time, you become the lessee (the party that pays for the use of the asset), and your financing partner becomes the lessor (the party that receives payments).
Sale-leasebacks usually involve fixed lease payments and tend to have longer terms than many other types of financing. Whether the sale-leaseback shows up as a loan on your company’s balance sheet depends on whether the transaction was structured as an operating lease (it won’t show up) or capital lease (it will).
The major difference between a line of credit (LOC) and a sale-leaseback is that an LOC is typically secured by short-term assets, such as accounts receivable and inventory, and the interest rate changes over time. A business will draw on an LOC as needed to support current cash flow needs.
Meanwhile, sale-leasebacks usually involve a fixed term and a fixed rate. So, in a typical sale-leaseback, your company would receive a lump sum of cash at the closing and then pay it back in monthly installments over time.
How Much Financing Will I Get?
How much cash you receive for the sale of the equipment depends on the equipment, the financial strength of your business, and your financing partner. It’s common for an equipment sale-leaseback to provide between 50–100 percent of the equipment’s auction value in cash, but that figure could change based on a wide range of factors. There’s no one-size-fits-all rule we can provide; the best way to get an idea of how much capital you’ll receive is to contact a financing partner and talk to them about your unique situation.
What Types of Equipment Can I Use to Get a Sale-Leaseback?
Most often, businesses that use sale-leasebacks are companies that have high-cost fixed assets, like property or large and expensive pieces of equipment. That’s why businesses in the real estate industry love sale-leaseback financing: land is the ultimate high-cost fixed asset. However, sale-leasebacks are also used by companies in all sorts of other industries, including construction, transportation, manufacturing, and agriculture.
When you’re trying to decide whether a piece of equipment is a good candidate for a sale-leaseback, think big. Large trucks, valuable pieces of heavy machinery, and titled rolling stock can all work. However, collections of small items probably won’t do, even if they add up to a large amount. For example, your financing partner most likely won’t want to deal with the headache of assessing and potentially selling piles of used office equipment.
Is a Sale-Leaseback Better Than a Loan?
A sale-leaseback could look very similar to a loan if it’s structured as a $1 buyout lease or equipment finance agreement (EFA). Or, if your sale-leaseback is structured as a sale and an operating lease, it could look very different from a loan. Since these are very different products, trying to compare them is like comparing apples and oranges. It’s not a matter of what product is better — it’s about what fits the needs of your business.
With that said, sale-leaseback transactions do have some distinct benefits.
With a sale-leaseback, your company may qualify for Section 179 benefits and bonus depreciation, among other potential benefits and deductions. Often, your financing partner will be able to make your sale-leaseback very tax-friendly. Depending on how your sale-leaseback is structured, you may be able to write off all the payments on your taxes.
Lower Bar to Qualify
Since you’re bringing the equipment to the table, your financing partner doesn’t have to take on as much risk. If you own valuable equipment, then you may be able to qualify for a sale-leaseback even if your business has unfavorable items on its credit report or is a startup business with little to no credit history.
Since you’re coming to the transaction with collateral (the equipment) in hand, you may be able to shape the terms of your sale-leaseback agreement. You should be able to work with your financing partner to get payment amounts, financing rates, and lease terms that comfortably meet your needs.
What Are the Restrictions and Requirements for a Sale-Leaseback?
You do need to meet two primary conditions to qualify for a sale-leaseback. Those conditions are:
- You need to own the equipment outright. The equipment must be free of liens and should be either completely paid off or very close.
- The equipment needs to have a resale or auction value. If the equipment doesn’t have any fair market value, then your financing partner won’t have a reason to purchase it from you.
What Happens After the Lease Term?
A sale-leaseback is usually a long-term lease, so you’ll have time to decide what you want to do when the lease ends. At the end of the sale-leaseback term, you’ll have a few options, which will depend on how the transaction was structured to start. If your sale-leaseback is an operating lease where you gave up ownership of the asset, these are the typical end of term options:
- Work with your financing partner to renew the lease
- Return the equipment to your financing partner, with no further obligations
- Negotiate a purchase price and buy the equipment back from your financing partner
If your sale-leaseback was structured as a capital lease, you may own the equipment free and clear at the end of the lease term, with no further obligations.
It’s up to you and your financing partner to decide between these options based on what makes the most sense for your business at that time. As an additional option, you can have your financing partner structure the sale-leaseback to include an early buyout option. This option will let you repurchase the equipment at an agreed-upon fixed price before your lease term ends.
Contact Team Financial Group to Learn About Your Business Financing Options
Have questions about whether you qualify for equipment sale-leaseback financing or any other type of financing? We’re here to help! Call us today at 616-735-2393 or fill out our contact form to talk with a financing expert from Team Financial Group. And if you’re ready to apply for financing, fill out our quick online application and let us do the rest.
The content provided here is for informational purposes only. For personalized financial advice, please contact our commercial financing experts.