When Bill and Peggy Kensi took over Royal Laundry of Texas Inc. in 1996, the company was breaking even with sales of approximately $500,000. With some focused marketing efforts, the potential the couple had seen in the business quickly materialized from such customers as Electronic Data Systems Corp., American Airlines and a large, local hospital group.
To answer the growing demand, the Kensis needed new equipment--and lots of it. Unfortunately, the cost of the dry-cleaning machines, automated folders and high-speed irons they required totaled about $500,000.
The Kensis tried to get a loan from several local banks but were rejected and referred to the SBA. Unfortunately, the SBA's timeline for loan approval was too lengthy for the Kensis, who needed their new equipment quickly. "Even though the business was almost 10 years old when we sought the loans, in the eyes of the bankers, it was technically a start-up because we had recently purchased it," Bill says. "None of them was willing to finance a company that [in their eyes] was less than 2 years old."
And even if they could find a bank willing to finance a start-up, the Kensis' personal guarantee, which would be required, wasn't worth much. "We had put everything we had into buying the business," says Bill. "We were cash-poor."
Enter Jim Lahti, president of Affiliated Corporate Services Inc., a Lewisville, Texas, equipment leasing company. Lahti took an interest in what the Kensis were trying to accomplish, and over the next two years, he structured approximately seven leases that got Royal Laundry of Texas the equipment it needed.
In addition to running Affiliated Corporate Services, Lahti is also president of the United Association of Equipment Leasing. Some of the greatest benefits of leasing, says Lahti, include rapid approval times, no down payments, more favorable tax treatment than with asset purchases, the ability to finance hard costs and soft costs such as training and installation, and, finally, flexible lease terms.
The differences between an equipment leasing company and a bank run deep. "When a bank makes a loan, you can pretty much do what you want with the money," Lahti says. "And if you buy equipment with the loan, you own it, depreciate it and pay back the bank. But a leasing company buys and owns the equipment and rents it to you. So one of the primary differences is ownership."
Another big difference is orientation. "What makes a leasing company more adventurous than a conventional lender," says Lahti, "is that we don't do business under the same federal regulations as a bank and we don't have the same audit trails as a bank." To underscore this difference, Lahti says his firm will lend up to $100,000 on a so-called "app only" basis. This means the loan underlying the lease can be approved on the basis of information provided on the application, which is generally no more complex than an ordinary credit card application. Lahti says there are leasing companies that will do deals of up to $250,000 on an app-only basis.
Finally, whereas most banks conduct a credit analysis--a detailed assessment of a business's financial position and its ability to repay a loan--leasing companies do not. Says Lahti, "We take the path of least resistance and try to figure out ways to make loans even faster."
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What's The Score?
Lahti says a robust economy and a plentiful supply of debt capital have generally made loans easier to get. But what's really put the supply of loan funds over the top is the use of credit-scoring models.
Credit-scoring represents a paradigm shift in business lending. With traditional credit analysis, businesses are analyzed for their debt-paying ability--a time-consuming and expensive process. In fact, the same credit analysis that's used for a $2 million loan is applied to a $200,000 loan--making the small-business loan application process slow and difficult.
But under the credit-scoring model, businesses are analyzed not so much on their ability to repay a loan but on the probability that they'll repay it. In fact, says Lahti, for leases of less than $100,000, a leasing company may simply credit-score the business owners' personal credit and check trade and bank references to reach a decision.
As a general rule, for leases of more than $100,000 but less than $150,000, a leasing company will credit-score a business and its owners and ask for a full set of financial statements. When leases surpass $150,000, would-be lessors face the same kind of scrutiny and analysis they'd face with almost any commercial lender.
So what are the red flags in a credit score that might cause your lease application to be turned down?
- Personal credit problems. Past delinquencies, slow payments or nonpayments will reduce your overall credit score.
- A high number of credit inquiries. If a lot of lending institutions are scoring your credit, it could be a sign you've made too many credit applications and are carrying too much debt.
- Lengthy payments on trade credit. If you stretch out payments to your vendors to 90 days, your payment history will negatively affect your chances of loan approval.
- A high number of NSF bank notices. If you continually write checks that are returned for insufficient funds, it will undermine your credit score.
- Lawsuits and judgments. These are never good signs for a lender.
- Frequent changes in banking institutions. Lahti says most lenders like to see at least two years of history with the same institution.
If your credit score comes up low, most leasing companies will take steps to make the deal doable. "In the trade, we call this structuring," Lahti says.
Popular structuring strategies include down payments on equipment; additional guarantors; and putting up additional collateral in the form of real estate, publicly traded stock, letters of credit and equipment a company already has. "If you already have equipment on your floor, that's equity," says Lahti. "You can use it as additional collateral. In fact, if you need working capital, we can buy your equipment and lease it back to you."
Scoring the Lease
In theory, there is no interest associated with a lease. "You write the whole lease payment off, just like any other monthly expense," Lahti says. With a bank loan, on the other hand, you write off just the interest portion of the payment and take an expense for the depreciation of the underlying equipment.
Still, you may want to gauge the cost of lease financing. To do this, you must know the residual value of the equipment you're leasing. This is the value of the equipment at the end of the lease that you would have to pay to purchase it. For instance, suppose you lease a $12,000 forklift for $300 per month for three years, and at the end of the lease, the forklift's residual value is $4,000. If you then buy the forklift, your total cash outlay would be $14,800 (36 payments of $300, plus $4,000). Because the forklift cost just $12,000 new, the difference between the original price and the total cash outlay is the implied financing cost--in this case, $2,800.
If you decide to go with a leasing company, such an analysis is a good starting point, but other factors must also be analyzed when comparing one leasing company to another: namely, the upgrade value, the flexibility to extend or modify a lease, interim rent payments, search and documentation fees, and speed of approval.
Let's Make a Deal
Although it's not apparent at first glance, the company offering the lease financing is often not the same one that's selling the equipment. Generally, the equipment seller will refer you to a leasing company with which it does business. Lahti advises you to get a quote from the leasing firm the company refers you to and then get another quote to judge the competitiveness of the first quote. "Get a second referral from the equipment seller," says Lahti, "or ask a friend or business associate."
If you look for a leasing company on your own, Lahti says, you should understand whether you're talking to a broker, who simply structures deals and gets them financed through any of the leasing companies he or she works with, or a leasing company, which puts its own funds on the line.
There's nothing wrong with using brokers, says Lahti. The situation is analogous to using an insurance broker, who finds the best deal for a client among many insurers and, at least in theory, generates savings in excess of his or her fees. But with brokers, as with many other professionals, the same advice applies: Buyer beware.
Back at Royal Laundry of Texas, business is booming, thanks in part to the expanded capacity. According to the Kensis, the current run rate is now $2.8 million, an increase of more than 500 percent since the couple took over the business.
Looking for a leasing company? For a referral, contact the United Association of Equipment Leasing at 520 Third St., #201, Oakland, CA 94607, (510) 444-9235, http://www.uael.org
Affiliated Corporate Services Inc., 1550 Waters Ridge Dr., Lewisville, TX 75057, (972) 221-7335
Royal Laundry of Texas Inc., 1015 Commercial Blvd. N., #600, Arlington, TX 76001, (817) 467-9678.