Many business owners are blissfully unaware that financing equipment through their current bank usually sees that equipment debt “bootstrapped” to any other securities the bank may hold (such as properties and other owned assets within the business). This bootstrapping typically comes in two forms:
1. Cross-collateralisation clauses (which sees all debt with the bank secured by all security held by the bank).
2. General security agreements (GSA), which is the new term for the old fixed and floating charges or registered equitable mortgages. This means the bank owns all assets of the business under this GSA.
Typically, banks do not go out of their way to tell business owners about these overarching securities, but it is most often the reality and a simple company search will tell a business owner if a GSA is in place over their business.
The sleeping dragon in this situation most often rears its head when a business looks to change banks and the outgoing bank insists on all equipment finance being paid out and the penalties incurred on contracts that are early to mid-term at that point. As an indication of those penalties, the cost to terminate a $1 million equipment loan that is one year into a five-year transaction is typically in the order of $40,000.
In a world where a dozen or so competitive banks and financiers are keen to finance equipment in its own right, without this bootstrapping, a company’s current bank is probably the worst place to have its equipment debt.
{{image2-a:l-w:640}}
Spreading the risk
The current bank does have a role to play in funding working capital such as overdrafts, as well as property-based requirements, and under these circumstances the bank having the benefit of property equity via mortgages over properties is completely relevant and commercially acceptable.
The provision of a GSA to a bank should only be granted by a business as a last resort, as it is in effect the granting of a mortgage to the bank over the entire company.
Many businesses spread their equipment debt across three or four financiers, as this creates a stable platform of supportive lenders for future growth and creates competition between those financiers to ensure competitive structures and rates are provided. This can be done by the client or through the use of a capable finance broker.
Remember, these lenders have no other asset as hard security, other than the equipment they have financed.
Impact of interest rates
In this increasingly competitive environment, where business owners are constantly squeezed on margins, any saving in expenses is beneficial.
Based on a simple $1 million debt over a five-year term, the following is worth noting:
• At 5.5 per cent, the payments are $19,100 per month.
• At 4.5 per cent the payments are $18,645 per month.
• The difference of $455 per month over the 60-month term is $27,300.
To put this into perspective, where a business has a net profit margin of five per cent, an additional $546,000 in turnover is required to offset this additional $27,300 cost, so attention to the cost of finance is always a worthwhile exercise.
Dispelling myths
{{image3-a:r-w:250}}Refinancing equipment debts towards the latter part of the contracts (in the last 12 to 18 months) can be done through
an increasing number of financiers. There are minimal penalties involved, the current interest rates would typically be about two per cent less than the initial debt and the refinancing of those debts on long-term assets will usually substantially reduce the monthly commitments, and in doing so free up cash flow that can cover in part the cost of additional equipment.
Equipment finance can be written with payments monthly in arrears, to allow a 30-day payment delay to assist cash flow. The cost differential between monthly in advance and monthly in arrears is minuscule.
For example, the cost differential on $1 million over five years would be:
• Monthly in advance – $18,573 per month.
• Monthly in arrears – $18,645 per month.
Used equipment, including private sales, can easily be financed, saving businesses significant dollars on the cost of equipment. Care does need to be taken around ensuring clear title on private sale assets, including company searches on the vendor, to ensure there is no dedicated debt on the asset or overarching GSA by their bank. A simple Personal Properties Securities Register search will show up any interests held on those assets being sold.
Major refurbishments of plant can also be financed on a term equipment debt, no different to repowering the engines of an aircraft, whereby the value of the aircraft is substantially increased.
CHP vs chattel mortgage
Beware the pitfalls of ad valorem stamp duty, which has been abolished in all states except New South Wales. Those businesses in NSW can incur this unnecessary stamp duty expense through the use of a chattel mortgage instead of commercial hire purchase (CHP).
Stamp duty on a $1 million machine under chattel mortgage is $3941 (add this to the cost shown above in interest rates and the dollars are starting to add up).
This cost is not incurred through CHP, and although there is GST payable on the interest component of CHP, the GST is a refundable expense.
Right term, residual/balloon
Business owners should ensure the term and residual/balloon they want on their long-term assets is the structure that suits them, and not what the bank dictates.
The same applies to deposits and GST.
There are many competitive lenders out there, so business owners should shop around until they get the right structure.
Being forced to pay off a $1 million asset (which has a 10-year-plus lifespan) over five years at $18,645 per month may be too heavy on cash flow.
Perhaps a five-year term with a 40 per cent balloon at $12,865 per month, followed by the refinancing of that $400,000 balloon over a subsequent five years at $7460 per month, is a better outcome.
Mark O’Donoghue is the founder and CEO of specialist business finance broking firm Finlease. Email: finlease@finlease.com.au