Are you one of those company owners driving through the dark, anticipating what’s on the other side of the tunnel? Many businesses are already positioning themselves for recovery even as the economy continues to sputter. Continued investment in machinery will be top of mind for operations looking to grow.
Higher interest rates are now in play, however, and are having an effect. To find out more, I touched base with two financing professionals for insights on the current market. Ian Liddell specializes in assisting pallet companies and frequently contributes to Pallet Enterprise. Additionally, I chatted with Brian Dineen, the managing partner at Trinity Capital Partners LLC. Trinity focuses on alternative capital sources for small and mid-sized companies.
Here are some of my takeaways.
The Bar Has Moved on ROI
When it comes to the current borrowing environment, ROI considerations should be top of mind. “Purchasers have to do a thorough job of determining exactly what kind of return they’re going to get off of that equipment,” Dineen said.
“When interest rates were down near zero, you didn’t need to do that,” he continued. “The money was so cheap if the machine operated and produced product that you could charge and make money from; that’s all you needed to know.”
In the present environment, however, you must use a sharper pencil. Even if you are an A-credit borrower and getting an 8.5% rate, and you are only getting a 10% return on investment on the machine, that’s a pretty thin margin, he observed. And if you are not an A-credit borrower, the rates get higher. “You need to make sure the equipment will generate the kind of return that justifies that cost of money,” Dineen continued. “I would say that’s Number One.”
Don’t Get Sticker Shock Paralysis
A second consideration in the current market relates to the peril of sticker shock. When companies begin their due diligence on machinery financing, today’s rates can catch business owners off guard. “When evaluating a piece of equipment, compare competing rates available today, not historical rates from 2020,” Liddell cautioned. He stressed that no one is trying to rip anyone off. “They’re just setting the rates based on how much they are paying for it and the level of risk,” he said.
“When a business goes to borrow money, not just equipment but for anything, they’ve got to adjust their expectations,” Dineen noted. “Banks are tightening up. They are getting much stricter as to who they will lend to and even what kind of assets they’ll lend on. You may have good credit, but you may still be forced to go to the alternative market.”
As a result, decision-makers need to perform current research and adjust their expectations. One thing Dineen is seeing is that some businesses are postponing purchasing machinery they need because they have been paralyzed by interest rate sticker shock and can’t get past it.
“If businesses are pessimistic short-term, but they’re optimistic long-term, and their financial decisions are solid, it can still make sense to finance,” Liddell said. “If they are pessimistic short-term and long-term, why are you still in business? You should probably just sell the company.”
Loan Structure May Be More Important Than The Rate
There are many ways to structure a deal, and Liddell emphasizes that it can be more important than the interest rate. There are three options – no payoff discount, partial payment discount or full payoff discount (principal only). For example, Accord Financial Group, the company Liddell works for, offers finance agreement which are not leases but equipment loans. These are commonly called equipment finance agreements.
When interest rates are climbing, one option is to lock in the financing even before delivery and begin making payments, so you are insulated from future rate increases that might hit before the machinery is ready to ship. If rates have gone up before delivery and the buyer is faced with higher rates, another option might be to put more money down to lower the monthly payment if cash reserves allow, Dineen added.
Another area of financing that can be important is the exit strategy. Be sure to review penalties and exit clauses with your lender. Loans can vary in terms of penalties for early completion. It can range from no penalty at all to a full interest payout. One example of when an early payout might make sense is if you are growing fast and need to upgrade to a higher-capacity machine. Liddell recently had an example of a client who did just that, trading in its current machine with no penalty, and swapping it for a new, upgraded model.
Convenient Borrowing Is More Expensive
The last thing a busy business owner wants is a complex loan underwriting process involving finding and completing “mountains of documents”, Dineen noted. In many cases, the explosion of online lending (FinTech) can make borrowing easier than ever, but it comes at a cost. “Understand that the more convenient the loan, the more expensive it is going to be,” he cautioned.
Protect Your Credit Score
As always, protect your personal and business credit scores. “If you are having struggles in your business and can’t make a payment, call the lenders and talk to them,” Liddell suggested. “They don’t want the equipment back,” he quipped. Lenders will help you work out a plan, but if you ignore them, it will damage your credit score.
Where possible, Dineen commented, make an effort to separate personal and business credit scores. This is an area where he helps his clients. For a small business owner, something like a divorce, for example, can be devastating to your credit.
Financial reputation is critical for pallet businesses. Unlike some operations, like restaurants, where most of the equipment is purchased upfront, pallet companies continually add and upgrade equipment and property over the years. If you take time to protect your credit score and show that you are a responsible business owner, you’ll be in a good position to return to the same lender in the future, Liddell concluded.
Editor’s Note: For more information, contact Brian Dineen or Ian Liddell. Brian Dineen, brian@trinitycpllc.com or (414) 588-5113 and Ian Liddell: iliddell@4sfg.com or (513) 293-4480.
