Shopping for Loans and Leases

Lynn Merrill

Refuse equipment is not cheap, so unless you have large cash reserves or made a fortune in the latest e-commerce IPO, you probably will be in the market for financing when purchasing your next big piece of refuse equipment. Consequently, understanding the available financing strategies and knowing where to look should help smooth the bumps in the road.

There are several routes to financing equipment. Financiers include original equipment manufacturers (OEMs) who understand both the product and the industry, leasing companies that specialize in third-party financing, commercial banks and brokerage firms.

Most financing falls into two categories: the straight purchase and lease financing. Most people buy large items, whether it's equipment, vehicles or real estate through a straight purchase arrangement. Here, asset ownership is transferred to the buyer upon sale, and is used as collateral for insuring loan payment. Failure to pay means the note holder can repossess the asset and sell it to retire the loan. In a purchase loan, each payment consists of a portion of the principal and interest. The interest may be tax deductible, and the asset may be depreciated.

On the surface, lease financing appears similar to a purchase agreement, but the lessor doesn't own the equipment until the end of the agreement term, if at all. Because the asset doesn't change ownership, no depreciation can be taken. However, the total lease payments generally can be deducted as an expense.

Leases either can be open-ended, where the asset may be purchased at the lease's conclusion for a nominal amount, or close-ended, where the asset is returned to the lease holder. Public entities usually use leasing to acquire equipment, because governments are prohibited from borrowing money.

Each financing arrangement has tax and cash flow advantages and disadvantages. Thus, it's a good idea to consult with an attorney and accountant prior to determining the right financing path for your circumstances.

For example, "the tax code restricts the amount of depreciation a company can take," says Luther Whitlock, vice president of the Waste Division of Financial Federal Credit Inc., Charlotte, N.C. "Consequently, if a small garbage company is in a tremendous growth pattern and it's purchasing a lot of equipment but not making a lot of money, because of the startup costs and the restrictions on depreciation that a company can take, leasing is advantageous." This way, the company has a direct write-off for items such as fuel expenses, he says.

On the other hand, if a company is very profitable, then a direct loan probably would be preferred. "Then [the company] would show the asset on its balance sheet and the corresponding liability, if it needs to depreciate."

You'd Better Shop Around As with any purchase, it pays to compare options. Commercial banks may offer certain financial packages that include checking, savings and payroll services. However, the bank's understanding of the waste industry's specific financial needs may be limited. Consequently, a banker may need additional information before he feels secure. In the end, the perceived risk of your loan usually translates into the interest rate charged. The greater the perceived risks, the higher the interest rate.

However, leasing companies with experience financing waste industry vehicles or equipment may more readily tailor direct loans or leases to fit your specific needs. Conversely, they may not be able to provide a full spectrum of financial services such as checking and cash management.

Many large waste equipment manufacturers, like Peoria, Ill.-based Caterpillar Inc., offer financing programs for customers who buy their equipment.

"All we do is lease or finance Caterpillar equipment," says Jim Flanagan, merchandising manager for Caterpillar Financial Services Corp., Nashville, Tenn. "We know how our customers use [the equipment] because we're involved in the sale and manufacturing. We have a better understanding of the application, the customer's needs and what's important from a financing and leasing perspective."

Financial management firms, which offer a variety of cash management programs, also can be an unexpected financing source. "Every company today needs to focus on its cash management," says Joseph Connolly, vice president and finance manager for Merrill Lynch, Palm Beach Gardens, Fla. "At a bank, [your accounts] typically are segregated," he says.

"[Banks are] prohibited from paying interest directly into a business checking account, so [banks] keep that separate relationship between operating and savings accounts," Connolly explains. Financial management firms, however, can offer a central asset account, which acts as an operating account, but earns interest daily.

"If a company needs to finance trucks or compactors, we can create a large-term loan and tie that loan to the deposit account," Connolly says. "Then, if [the company] has $100,000 in that account tonight, their loan will be paid down by $100,000 tonight. In essence, the $100,000 is invested at whatever rate their interest expense is, which always will be higher than a savings rate."

Connolly also says financial management firms can offer term loans and lines of credit.

The Building Blocks Whichever equipment financing option you choose, you must establish a strong relationship with the leasing or lending agency. Helping your financier understand your business is a must.

Ventura, Calif., hauler E.J. Harrison and Sons' relationship with a major bank developed over time. "We used to deal with about six banks because it seemed like we got better results by borrowing a little here, a little there," says Myron Harrison, financial advisor for the company. "We started dealing with a local bank, which took pretty good care of us until our needs grew. [Eventually,] we needed lines of credit to buy these new barrels because when we bought them, we spent $5 million to $7 million in a year or two just buying barrels. Prior to that, we pretty much paid as we went."

Sticking with one bank it had worked with for 40 years, Harrison says the relationship between E.J. Harrison and the lender was a long-term affair - cultivated by clear communication.

"I met [the bank's] financial officers and showed them our business plan," Harrison says. "We told them where we expected to be in one to five years to convince them that we were a good risk. They like to know we have long-term contracts ... so they don't see me losing a big city that affects my ability to pay them. If I go to a city council meeting to renew a contract, the bank goes with me."

Options for Startups For startup operations without a banking history, financing is available, but expect a thorough examination.

"[Financing companies] are going to look at [startups] pretty thoroughly," says Michael Knaub, vice president of sales for Schaefer Systems, Charlotte, N.C. "The companies we deal with know the private sector because they're already leasing them commercial containers and trucks. So, they know the companies and their credit histories surprisingly well."

Nevertheless, opportunities exist for new startups today. Even for someone emerging from a merger or acquisition without a job can show how well they know the industry, Knaub adds. Typically, leasing companies want a company to be in business at least three years. But, he says, they're making exceptions to that rule today based on the borrower's experience.

Character or Case History When talking with financial organizations, bring a business plan that tells where you're going, and financial records that show where you've been. The type of information required will depend on both your company and the financing company.

"While we review financial statements, the main things that we use [to determine financing] are their character, their credit and payment history, the need for the equipment and their experience in the waste industry," says Financial Federal Credit's Whitlock. "We don't look at ratios as much as other lenders. We look primarily at the need for the equipment and the revenue stream value should they elect to sell their company."

For example, Whitlock says an established company with a 5-year-plus track record would be asked to provide a couple of year-end statements, the latest interim statement, an equipment list, what equipment it would like to purchase and why the company needs the equipment. "Then I can make a decision based on that," Whitlock says.

"If the company is relatively new, I probably would revert to the [borrower's] character," he says. "I would want a personal financial statement, a resume showing their experience in the refuse business and a business plan - written or verbal. I can write down [their plans] and come up with a cash flow projection."

Of course, each financing company uses it's own criteria for making a decision, based on items such as the borrower's business experience, creditworthiness and potential. Some companies, however, may not be able to provide financing based on those parameters. For example, Connolly says before lending startup money, his company would have to completely understand the borrower's history.

"We would want to know at the outset, that some revenue would happen immediately," he says. "In other words, [the startup should] have contracts that are rock-solid. We've got to base our [decision] on a historical track record. It's very difficult to underwrite a [startup] business like that because we obviously can't ask for a track record. If [the owner] tells us, 'I'm bringing over half the business from another company,' and we can verify that, then that's a track record."

In some cases, the personal creditworthiness of the business' principals will make or break the financing deal. For example, when E.J. Harrison set out to build a $15 million transfer facility, the lenders examined Myron Harrison and his brothers, as well as their business. "We put up personal financial statements and guaranteed all the notes," Harrison says. "Like any lender, they still want to make sure you can service a big chunk of that note personally. We were able to get the funding, but they also wanted to make sure we could pay for it if we had to."

In the meantime, the financing industry also is undergoing changes as much as the waste industry is consolidating. But while the players may change, don't expect to see radical changes in financing vehicles. Instead, look for repackaging of the same types of financial programs.

"It seems the finance industry is looking for a better mousetrap or a new way to loan money," says Caterpillar's Flanagan. "My experience has shown that every possible method has been used over the past 20 years, and there is nothing new from a finance perspective.

"Today, customers are looking to transfer more of the equipment risk to the manufacturer and/or the vendor," Flanagan continues. "As a captive finance company, we see an increasing trend toward operating leases, leases with up-time guarantees and maintenance included within the lease so that companies have a total maintenance and repair contract. That's where the industry seems to be headed. A customer will be able to quantify their total equipment cost."

In the long-run, the secret to successfully financing equipment is to provide good solid information to a financing organization about your business' past and present, as well as future opportunities. Not every financing institution will say yes, so research and perseverance are key. And, according to Harrison, the most important criteria to receiving a positive response to your financing request is to "pay all your bills on time."