The collision industry is evolving. Cars are becoming more complex. OEMs are becoming more involved in setting and enforcing repair standards. Even without OEM involvement the tooling, training, and equipment required to fix cars continue to increase. In short, the cost of operating a collision repair business continues to increase.
The Evolution of the Industry
Historically, the industry has not had a high level of capital intensity (Capital refers to things like spray booths, prep stations, frame racks, etc. Generally, the costs related to purchasing a long term assert can be thought of a capital cost.) In the past, assets that were purchased had long-term lives. The costs associated with those assets could be spread across many years.
But the industry continues to evolve. Capital intensity is increasing in the industry. The introduction of advanced repair materials requires significant investments in new tooling and training. Changing technologies renders even recently purchased equipment obsolete. Increasing OEM involvement requires continual investment in new tools and technologies.
Further complicating matters, many of the new technologies and new equipment required have a limited return over the short term. The aluminum F150 is just beginning to enter the vehicle fleet. According to data from Assured Performance, approximately 1,200 repair facilities were Ford Aluminum Certified at the end of 2015. With an average cost of $50,000 in new tools, equipment, and facility upgrades per facility, the industry has invested approximately $60 million for aluminum repairs. But according to a newsletter from Assured Performance, only $500,000 of aluminum F150 repairs were completed in the first half of 2015.
But aluminum repairs will increase over time. More aluminum F150s will hit the market. Aluminum is increasingly the substrate of choice for a number of manufactures. Even so, it takes time for the aluminum vehicle fleet to ramp up. This presents a frustrating dilemma to shop owns who want to invest now but who will not see a return for potentially a number of years. Purchasing tens of thousands of dollars of equipment to watch it sit idle for months is a difficult, and often frustrating decision.
What is Equipment Financing?
While it is common in the collision industry to purchase equipment outright, in other industries that have higher capital intensity, purchasing expensive equipment is a foreign idea. Take for example commercial construction. It is cost prohibitive for many commercial construction firms to own the heavy equipment required to complete a project. Instead, the heavy equipment — tractors, cranes, etc. — are leased, financed or rented.
Financing equipment or facility upgrades is commonplace in many industries. While many of us were raised with the notion that debt is bad, the reality is that debt is simply one tool of business finance when prudently used. A core tenant of corporate finance is that the liabilities of the firm ought to match the assets of the firm. So if a business acquires an asset with a projected 15-year life, the business is well served to finance the asset over the course of 15 years. In that way, the expense and cash flows related to the asset are appropriately spread over the useful life of the asset.
Take the investment required in tooling and facility upgrades to become Ford Aluminum Certified. A $50,000 investment to complete a few thousand dollars of repairs annually seems absurd on the surface. However, when the cost is spread over the useful life the assets acquired, say 15 years, the expense appears much more reasonable. While the business may still recognize an initial loss in the first few years of the investment, it is likely the business will recognize a return in later years that will more than offset the initial investment.
The benefits of equipment leasing
There are a number advantages leasing brings to a business, all of them revolving around improved cash flow and flexibility. Equipment financing is more than merely moving numbers around on a spreadsheet. Appropriately managed, equipment financing will actually help reduce the risk of your firm and increase the stability of your cash flows.
Tax Advantages: Depending on the structure of the lease, lease payments can reduce taxable income in a more appropriate manner than depreciation alone. Seek out the counsel of a licensed tax advisor to discuss your specific situation. But generally speaking, operating lease expenses can be fully deducted when incurred for tax purposes.
100 percent Financing: When leasing equipment, most equipment lenders will lease up to 100 percent of hard equipment costs, and many will also finance the soft delivery and installation costs as well. In tradition bank financing, there is often a down payment required and banks are less willing to finance soft costs.
Balance Sheet: When you lease an asset, you pay for the right of use, not the right of ownership. As such, items that are leased do not appear on your balance sheet as an asset. And a lease does not appear on your balance sheet as a liability. Because there is no liability on the balance sheet there is no collateral required to offset the liability and your business assets remain unencumbered — a very important aspect if you are considering future sale. If you are looking to grow utilizing leases will also make your asset base appear more productive, important if you are seeking financing for acquisitions.
Flexibility and Obsolescence: Another key advantage of leasing rather than owning equipment is avoiding equipment obsolesce risk. Many companies opt to lease computer equipment and software to stay up to date with rapidly changing technology. Lease terms can be for a few months, or for the entire expected life an asset, depending on the need of the business.
Common types of equipment financing
There are a lot of different options when considering ways to lease or finance equipment. But these are the most common I see when helping clients finance equipment:
· Operating Lease (Fair Market Value Lease)
· Capital Lease (Dollar Buy Out Lease)
· Vendor Financing
· Bank Financing
Operating Lease: What most people think of when discussing leases, an operating lease allows for the use of an asset without owning the asset. Operating leases are often structured to have a “Fair Market Value” purchase option at the end of the lease term where the lessee has the option, but not the obligation, to purchase the asset at the current market value. A vehicle lease is an example of a common fair market value lease.
As mentioned above, the expenses associated with an operating lease are generally fully deductible for tax purposes. Check with you tax preparer regarding your specific situation.
Capital Lease: Whereas an operating lease transfers the risk of ownership to the lessor, a capital lease more closely resembles a traditional loan, but without actual ownership. The lease term tends to be longer than operation leases. Capital leases include a “dollar buy out” clause at the end of the term whereby the asset is transferred to the lessee. Because capital leases very closely resemble ownership, they also have different tax treatment than operating leases. Again, check with you tax advisor to get specifics on your exact situation.
While capital leases and traditional financing are very similar, capital leases have two main benefits over bank financing. First is the ability to finance 100 percent of the asset. Second is the ownership and collateral. In a capital lease, the lessor owns the asset until the lessee purchases the asset at the end of the lease term. Because the lessor owns the asset no collateral is needed by the lender.
Bank Financing: Your commercial bank likely provides general equipment and/or expansion loans. These loans are structured as traditional fully amortized notes, meaning the interest and principal is spread out over the full term of the note. Depending on the bank a down payment is often required.
Bank loans are secured by a UCC filing. Many banks file a blanked assignment where all the business assets are pledged as collateral. These pledges of collateral may seem innocuous but can become very onerous in the event the business seeks additional financing for growth or there is a change in control due to a sale.
Vendor Financing: Some vendors will provide financing for the purchase of equipment. Rather than carrying the note, most vendors partner with a financial institution to provide credit to the purchaser. These loans tend to resemble a line of credit, similar to a credit card. The initial terms can be quite attractive but can quickly become onerous if the principal is not repaid within the teaser time frame.
Managing Equipment Finance Options
The financial demands necessary to manage shop equipment will continue to increase as the industry evolves. Building a relationship with a local banker will go a long way in helping simplify some of the complexity around purchasing and financing equipment and ensuring you have access to financing when you need it.
