Less than two percent of our lease portfolio have transactions with additional collateral.
We look toward the cash flow of the business, the credit of the company and its principals, plus the nature of the business. We do not have a fixed formula as most national leasing companies. We look at the individuals behind the company, the business plan, and the cash flow. We are not net worth or collateral creditors.
Our company motto, and it is original, trade marked over twenty five years ago: Cash Flow is King.
We look at the story behind the company, rather than its credit scoring . We have written leases that require additional collateral. Often lessors are willing to take more of a financial risk when they obtain both the depreciation and profit by being the creditor. When they extend credit, it is not uncommon for them to require "other" collateral.
We have done this when we really like a company, but need something more to convince our investors, our credit committee, or lines of credit to change our general criteria. Sometimes it is a little "extra."
"Extra" meaning more than the original equipment. Often the instance is not "credit worthiness," but the value or nature of the equipment.
Other collateral is expected. We view this as increasing our "abundance of caution."
Here is the list of typical collateral, in order of significance to the lessor:
A typical lease requires one month as a security deposit. This deposit is not income to the lessor, but held as a deposit for losses not only against the specific lease, but all leases. On the lessors financial statement, its place is long term liability. It is not earned until the end of the lease and most commonly is used in lieu of the last lease payment.
To make the lessor more comfortable, often two or more security deposits can be required. This is particularly true when the income has a short life, and the lease is longer than the life of the equipment.
It is also not uncommon for a lessor to require a ten, or twenty-five, and sometimes a fifty percent deposit. Usually there is not any interest earned on this deposit to the lessee. Often the deposit is not held for the full length of the lease, but a specific time limit and other requirements, such as a history of payments made on time or financial criteria. The deposit is an incentive to obtain a credit approval on the lessee and equipment.
We have written many ten percent deposit leases, plus several twenty-five percent deposit leases, and in over twenty-seven years, at least a dozen fifty percent deposit leases. When money tightens again, this type of structure will be more prevalent than it is today.
This is very similar to cash, except the lessee earns the interest on the "deposit" Often the Certificate of Deposit is held at the lessors bank.
It sometimes is held at the lessees bank, but there are many restrictions and procedures in place. It is also not uncommon to find the CD from a "guarantor" or third party, such as a company that will realize the appreciation of the equipment and performance of the lessee with the equipment. Trusts and other entities may also have the ability to pledge a certificate of deposit. Time limit and other considerations may be made, depending primarily on the size of the transaction and situation.
American Leasing has written over a dozen leases in the last few years with certificate of deposits. These are generally leases where the lessee qualifies for a smaller lease, but wants a large lease and the company is often moving to a major plateau.
Letters of Credit
The lessee obtains a letter of credit through their bank. It may come from their bank relationship, meaning accounts receivable, other loans, or personal guarantees of value to the bank. Costs are normally between one to two percent per year.
The letter of credit may also be in a step manner, meaning each year the dollar amount decreases as the lease is paid out. It is most common for the letter of credit to cover the entire stream of payments, not just the cost of the equipment.
Sometimes the letter of credit replaces a personal guarantee, a restriction of the nature of the equipment We completed a $300,000 letter of credit lease with a law firm, utilizing one personal guarantee and none of the other partners. We completed a $75,000 lease with a letter of credit and other equipment as collateral. We like letters of credit more than a cash deposit, but ranked number two because in the leasing business, additional security deposits are more common.
In this instance, the stock is most common physically held by the lessor or its bank or stock broker. There are instances when the stock is held by a third party. It is not uncommon for the stock to be valued at 50% of its selling price, or in other words, on a $50,000 lease, $100,000 worth of publicly traded stock to be held by the lessor. In all the instances we have seen, the full dollar amount of the lease is required to be covered by a publicly traded stock, municipal bond, or other such instrument.
Warrants are a form of stock. This is very common in Venture Backed Leases. A warrant is issued by the lessee, meaning the value of the stock "today" is promised to the lessor with the ability to purchase at any time in the future ( there can be time limits, but not common to require ). This gives the lessor the advantage that a new company starting out with a stock value of $5 may go to $50, or better yet, split several times, and it multiplies to be worth $125 or more in three to five years. It is an incentive to extend credit to a company not turning a profit or expected to turn a profit for several years. It is also attractive to investors or smaller leasing companies who are willing to extend credit with warrants.
This instrument has become so popular with banks and venture capital groups in the last few years, that the dollar amount considered has gone down to $100,000 (usually the minimum was $500,000).
Contrasting warrants, smaller transactions, where the credit or situation is not present, or company is new, pink slips to vehicles are held by the lessor. A vehicle appraisal, condition report, and department of motor vehicle processing is required. In many states, the highway patrol, motor vehicle department, can perform a condition report. Often a third-party vehicle dealer is used for both the appraisal and vehicle condition report. Often the lessor utilizes a "blue book" and sight inspection by a leasing officer.
In the past we have written several of these leases, trading pink slips for collateral substitution. This is more common with new tow truck operators or sub-contractors in the construction industry.
We have had mothers and father's guarantee for their childrens new company or management of their existing company. This applies to all ages. We had a 68 year old mother guarantee her sons expansion of his business. We were very glad when the lease was completed because no matter the financial situation of the guarantor, we did not want to collect from grandmother.
Normally, the guarantor is a "blood relative." Sometimes it is a corporate guarantor, such as from a corporation out of the state, often foreign, who has started a "presence" and new corporation in the United States. In California, we have several leases guaranteed by a Canadian, Israel, British, or Finish parent corporation. We also have leases from out of state corporations, such as one guaranteed by the Texas Corporation parent or former corporation who sold one of their companies to their employees in an ESOP plan.
The older credit days of obtaining a guarantee from a best friend are gone. Creditors found when it came to collecting money from best friends, the friendship ended and only the attorneys were paid.
Informal appraisals from dealers or other parties are most common, using the depreciation schedule in the tax return to verify cost of equipment and value of the equipment. It is not uncommon to require 150% of the depreciated value in lieu of a formal appraisal that may cost the lessee three percent of the evaluation from a professional appraiser.
A UCC search may cost up to $250 to verify that the equipment is "free and clear" from other blanket liens or specific liens. It is not uncommon for the process to take two to four weeks longer to clear up liens that have not been released or for debtors to be paid off. Often this is also viewed as a "sale-leaseback," meaning a bulk rate filing in a local newspaper for ten days is also required.
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