Lease, Loan, or Cash?

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Not sure how to pay for your next machine tool? Michael Fox of Mitsubishi HC Capital Canada has some important advice. PHOTO courtesy Seko Tools.

By Kip Hanson

So you’ve decided on another CNC lathe or mill for your shop (or maybe it’s your first). Your customers are on board, you have a few months of work lined up, and after a little shuffling, have found just the spot for it on the shop floor. The only question now is how will you pay for the darned thing?

Meet Your Friendly Banker
Michael Fox has a few ideas. The Vice President of equipment finance for Mitsubishi HC Capital Canada (MHCCA) in Burlington, Ontario, works with DiPaolo Machine Tools and other distributors throughout the provinces to find the most effective financing solution for their customers. 

Shop had a chance to sit down with Fox recently and pick his brain about the financing options available to shop owners and the pros and cons of each. Here’s what he had to say:

SHOP: Start by telling us a little bit about Mitsubishi HC Capital Canada.

Fox: We are part of the Mitsubishi Corporation, which is a global conglomerate. As you might know, our company produces CNC machinery and laser equipment for the manufacturing industry, but my area of expertise is within the financing division. We offer solutions for a wide array of assets, including transportation, construction, manufacturing, and sustainable development projects like commercial building technology upgrades that help companies cut costs. Part of that is collaborating with dealers and manufacturers to offer financing to their customers. Ultimately, our objective is to empower our partners to sell more equipment through our financing solutions.

SHOP: Equipment buyers have a lot of options. What should I look for in a lender?

Fox: If I were to advise someone on what to look for in a financial institution, there are several key factors to consider: 
• Start by finding a lender that has a solid history and is likely to be around in the future. 
• They should abide by all regulatory requirements, especially in Canada, where lenders operate under very stringent financial governance and compliance regulations. 
• Also, seek a company that offers financing with some flexibility. They should be able to accommodate varying circumstances and needs.
• It’s not just about selecting a financial institution but finding one that aligns with your specific requirements and can provide the most suitable financial solutions.

SHOP:What did you mean by flexibility just now?

Fox: Let’s say you need to borrow $500K and want to pay it back in 60 months. That’s simple enough, but will they offer to let you skip payments at certain times of the year? Can you delay your first payment by six months, giving you a chance to ramp up and get some cash flow going? Are they competitive on rates, will they offer longer terms, and how involved is their credit evaluation process? There’s a lot more to think about than simply getting approved to buy the equipment.

SHOP: Is it better if the bank or financial organization specializes in machine tools?

Fox: Maybe they’re experienced in financing trucks but aren’t comfortable with forklifts, or perhaps they have expertise in laser equipment, but not lathes or mills. You should choose a partner who understands your specific business and takes that knowledge into account during their underwriting process. Another crucial aspect is their service level. Hopefully, you won’t need much once the financing agreement is up and running, but if you run into trouble for whatever reason, the institution’s service level becomes critical. There’s also speed of setup. Oftentimes you can’t take delivery of your equipment until it’s paid for or you get a purchase order from the banker, which can lead to delivery issues.

SHOP: What about leases vs. loans? Which do you recommend?

Fox: That’s a very complicated question. But simply put, for a million-dollar piece of equipment, you borrow a million dollars, a lien is placed on the equipment, and you typically roll the taxes into the balance. This is because the tax is paid upfront and monthly loan payments aren’t taxable. Leasing works a bit differently. You don’t pay the tax upfront; it’s applied to the monthly payments as you go. Depending on your company’s financial situation and goals, there may be tax implications that could be more beneficial under one option than the other. You should fully understand these nuances before making a decision.

SHOP: I had a lease on my car once and got burned when it came time to turn it in. How do equipment leases work?

Fox: The most popular type is known as a TRAC, or Terminal Rental Adjustment Clause lease, which essentially functions like a loan. For instance, if it’s a hundred thousand dollars and after four years you’ve paid it down to zero, the leased item becomes yours. It’s like paying off a balance with some minor interest adjustments. Then there are Fair Market Value (FMV) leases. Here, you agree to lease an item for a specific period, say three years, at a set monthly rate, like $3,500. If you terminate early, penalties may apply. At the end of the lease term, you don’t owe anything. You can return the item, provided it meets the return conditions, or you can choose to lease it again at a new rate. And if you want to buy it, the price is determined by a fair market value assessment. This type of lease is useful for situations where you have a term contract to manufacture widgets. Once the contract ends (which hopefully coincides with the lease terms), you can simply return the equipment to the bank. So, the choice between a loan, TRAC lease, or FMV lease will depend on various factors, and the best option will vary depending on the specific circumstances.

SHOP: What about variable-interest loans? Just like my car experience, this didn’t work out too well on my home mortgage. Steer clear? 

Fox: Not necessarily. Most lenders set a rate on a specific date—say 8% on June 14th—and you’ll pay your lease based on that 8% for the next 12 months after that date. However, the market rate is certain to fluctuate during that time, so they’ll do a reconciliation at the end of 12 months. If the rates were higher on average over the year, you’ll have to pay the difference. Conversely, if they went down, you’ll receive a credit. That’s the risk you’re taking with fluctuating rates. We don’t see this as much as we used to, especially given the volatile market in the last year or so. That being said, with the current high rates, some people are considering floating rates as they anticipate that rates can only go down. But most prefer the certainty of knowing exactly what they’ll be paying for the lease term and don’t want any surprises, so most deals these days are done with fixed rates.

SHOP: This could be more of a question for a machine tool distributor, but is it a good idea financially to turn over equipment every five to ten years?

Fox: Consider it this way. Suppose you buy a piece of equipment for $100,000 with an operational life of 15 years, given a regular shift and production schedule. But at some point, you’ll start to see maintenance costs begin to go up. We used to demonstrate this with a graph, where your fixed costs were represented as a straight line and your operations costs as a curve that rises over time. The point at which these two intersect is theoretically when you should consider replacing the equipment. Your operating costs have become higher, thus raising your overall costs beyond initial expectations. At this stage, it may be time to sell the machine and bring in a new one. Often, people don’t view it this way, but financing can assist in facilitating this turnover. For instance, with a five-year lease and a 35% residual, if the equipment is worth 45% or 50% after five years, you can opt to trade it in or sell it to buy the latest model. While the cost may increase due to the acquisition of a new machine, you also gain the latest technology and improved efficiency. SMT

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