While some assets depreciate, others do not. Tom Toton of Corcentric (formerly AmeriQuest Business Services) explains why it makes more sense to add to your sales team and become asset light rather than putting equity into depreciable assets.
As the owner of a business, you need to take that same viewpoint when you are looking at investing in assets. Every business has a value and it does not matter which valuation method you use to determine it. Some of the common ones are EBDITA, (earnings before depreciation, interest taxes and amortization), net income before tax, net after tax or price-to-earnings ratio.
Whatever the earnings measurement, a multiple of those earnings creates the value of a business in the marketplace. Many companies look at their earnings to determine what they are worth and then use this data to figure out how to increase their value.
Unfortunately, when they use EBITDA as the measurement they may avoid leasing their transportation equipment as an option because the interest is an add back. Realistically, they should be leasing even if it is the same amount of cost and the same amount of net earnings. By leasing, rather than owning the depreciating asset, it can actually make the company more of an “asset-light” company, which can increase their multiple for valuation purposes.
The old rule of thumb is that a traditional heavy trucking company is worth five times EBITDA. That also can translate to three times net income before taxes. If you have the same earnings, but do something that increases your multiple, you increase the value of your company more substantially than any differential in cost.
For example, if a company has $10 million in earnings and their multiple is five, they are actually worth $50 million. If a company worth $50 million went with operating leases, it would be perceived as more asset light and their multiple might be eight. They still have the same overall expenses but they move the depreciable asset out of fixed assets, as well as eliminate the residual risk of resale at the end of optimal economic equipment life. With the multiple moved up, the company valuation would now be $80 million. So, the value went up $30 million and the company has not changed anything other than giving ownership of the asset to the leasing company.
Many private companies that do their own equipment financing take a traditional loan from the bank, but in doing so have equity tied up in that depreciable asset. They do not realize that the investment — exactly like the mutual fund example — produces dividends, which is the equivalent of retained earnings, and delivers capital appreciation on the value of the investment, but without having to invest any more money.
Why? Because they are using the leasing company’s money. Companies finance the full amount of the asset, then pay it down to a residual value, and a traditional lessor takes the equipment back and sells it to the marketplace. So in essence they are only paying for a portion of the asset they use, but realistically they could have become an asset light company.
Additionally, when you look at the weighted average of capital for a business, it is not just the interest rate that the bank charges for the loan; there is also a company’s equity. Weighted average cost of capital for a company is much higher than the interest rate that the bank is charging.
The new tax laws now include a lower tax rate for ownership on the federal side, as well as the 100% business depreciation schedules that are used on the asset. This makes true equipment leasing the mathematically better way to finance a depreciable asset versus buying, as it relates to the net after tax cost for ownership.
The lease-buy analysis is in most cases favorable to leasing. The weighted average cost of capital is lower when using someone else’s money rather than your own. Add to that the fact that you have the multiple of the company moving up as another way to increase a company’s value.
And here’s the icing on the cake benefit: if your own money costs 10% and you get a higher rate of return for having that money in your business, you should invest in the things that make your business grow or have more appreciable value.
Examples of things that enhance the value of a company could be software that increases the productivity of a workforce, or additional sales personnel, and financing to expand into other product lines or other business models. A truck, trailer, machines, even real estate, can sometimes decline in value over time.
So my advice would be this. Instead of borrowing from the bank and having to put 20% equity into a depreciable asset (that is not even winning the lease-buy analysis), put it into hiring more salespeople, investing in personnel training or offering bonuses to attract and retain the best and the brightest.
In other words, invest in the things and people that will appreciate your company’s value. You will be better off for it.
You can win the lease-buy scenario, become asset light and improve your multiple and valuation of your mutual fund investment, so to speak, by putting your money into things that go up in value instead of down. Overall, leasing your transportation equipment is a much more favorable route than relying on traditional bank financing or even using your own cash.
Banks have been growing in prominence in the equipment finance and leasing industry. At this point, they are far and away the most dominant segment of the market, as evidenced by the data in the Monitor 100 and the Bank... read more
Monitor 100 2018
It used to be so easy. Lessors would attach schedules of casualty values and early termination values to an equipment lease agreement. These values typically were expressed as a percentage of the lessor’s cost of the items of equipment suffering... read more