Equipment manufacturers often say that right now is the best time to make a major investment in their machines, even in the midst of a recession. Interest rates are at record lows right now, but this doesn’t necessarily mean a purchase is the best financial case for a given manufacturer, as cash flows are significantly hindered. And when the calls for action don’t stop, the efficacy of these investments is put into question. Unfortunately, this blinds manufacturers when it comes to making the real decisions that will affect their business.
Fortunately, there are ways to invest in new equipment that offer advantages based not on the economic recovery or constantly-fluctuating interest rates. One path is through a tax-exempt lease, which can help save a manufacturer a good deal of cash in the long haul due to its unique structure. On a fundamental level, a tax-exempt lease is a structure that allows the lessee — in this case, a manufacturer in need of new equipment — to receive a tax-exempt rate on their financing terms.
Peter Bullen, Senior Vice President and National Sales Manager, Bank Channel, for Key Equipment Finance says, “If we offered a client a $5 million lease to buy equipment, and we offered a tax-exempt lease, that rate could be as much as 2 percent lower.”
How does this happen? Unlike a traditional lease, which is an arrangement between a bank and the manufacturer, a tax-exempt lease brings in a third party: a government issuer. Bullen says this third party could be a local municipality, county, port authority, or even a state, as long as the manufacturer has production assets in that issuer’s jurisdiction. With the governmental issuer involved, the three-party agreement becomes one where “the bank has a lease with the governmental agency, and the governmental agency has a sub-lease with the company that’s buying the equipment,” Bullen says.
The benefit for manufacturers is that the governmental body has the power to issue tax-exempt debt, which is why this structure offers a lower effective interest rate in comparison to a traditional financing agreement.
And while the lowered interest rate sounds like reason enough for a manufacturer to look into a tax-exempt lease, there are other benefits, according to Bullen. He says that because the governmental issuer is involved, the duration of the repayment period is often longer. “Typically a bank would go 5 to 7 years,” he says. “Under [a tax-exempt lease] scenario, it’s not unusual for it to go as long as 10 years.” On simple terms, this means smaller monthly payments, which eases the financial burden on manufacturers.
Many potential governmental partners are allocated a certain amount of tax-exempt money to provide to manufacturers for these types of loans on an annual basis, and they want these funds to be utilized, mostly because it’s in their best interest to fuel investment. In addition, Bullen argues that adding the governmental body doesn’t actually add much additional red tape for the manufacturer — once the deal has been brokered, it is primarily between the manufacturer and the financing bank.
The lower interest rate can’t come without a catch, right? It’s true — there are some concerns potential purchasers need to keep in mind. First of all, the purchase has to be for manufacturing equipment. A warehousing or distribution center can’t take advantage of these funds, according to Bullen. A certain amount of real estate is allowed, but Bullen says, “Typically, the financing for the real estate can’t be more than 25 percent of the total amount.”
The investment must also be in new equipment, not used. While a traditional financing agreement allows for the purchase of used equipment, a tax-exempt lease is meant to fuel new investment, as it aids the economy on multiple levels: an equipment manufacturer makes another sale, and the buyer gets a brand new piece of technology that helps them operate more efficiently or at a reduced cost. If one is looking to specifically purchase used equipment, it’s best to look elsewhere.
Bullen says that there is also a limit on how much an individual company can finance through these deals. “There is a limitation of $10 million. From a governmental perspective, they’re not looking for a Fortune 500 company to avail themselves of $100 million in tax-exempt financing,” he says. On top of that, the company must do some math to determine if they’re eligible. They have to look back three years and forward three years, and tally up all that they have acquired, along with what they’re going to acquire. If that amount, in addition to what they want in tax-exempt financing, exceeds $10 million, they’re no longer eligible.
Bullen says these restrictions are in place to ensure that smaller companies take advantage of the tax-exempt debt, not major multi-national firms with plenty of cash on hand to make investments. With that in mind, many tax-exempt leases have certain requirements when it comes to job creation or retention. This is done on a case-by-case basis, and there are no standards from municipality to county to state, so it’s up to the manufacturer to ensure that they agree to a job creation requirement that’s actually feasible.
In addition, Bullen says it’s important to not get these tax-exempt leases confused with industrial revenue bonds (IRBs), which have a similar three-party structure. He says the “difference with the IRB is that it is a bond that is placed into the market and typically bought by investors,” which means that the manufacturer must get a letter of credit. This guarantees the bond but accrues additional fees, which could amount to one or two percent of the financing. Tax-exempt leases, on the other hand, stay with the issuing bank, which means no letter of credit is required.
Both have their own distinct benefits, so Bullen says it’s best for manufacturers to seek out those who are knowledgeable of both to help make the best decision.
Where should a manufacturer go to take advantage of a tax-exempt lease, then? Bullen says that oftentimes, a good choice is to turn to a bank that the manufacturer had previously worked with, especially if it involved equipment financing. The problem, he argues, is that smaller banks often don’t have the expertise on how these tax-exempt leases work, or they don’t have the personnel to devote to formulating a deal. Bigger banks might have this knowledge, but perhaps aren’t as comfortable with the structure, and won’t provide as much personal service. Bullen argues that companies such as Key Equipment Finance are among the better solutions, as they have the requisite knowledge and expertise to deal with tax-exempt leases.
Perhaps there truly isn’t a “best time” to make an equipment investment — manufacturing leaders know they can’t run their business based solely upon greater economic trends or what a consultant says. There can, however, be smarter ways to approach the possibility of making a large investment in new manufacturing equipment. For those who are considering such a purchase, it’s worth pursuing the possibility of a tax-exempt lease. It won’t work for every business, but for those with a good fit, there’s no doubt the lowered interest rate could make just about any time an opportune one to take the next step in a business’ growth.
Peter K. Bullen is the senior vice president and national sales manager, bank channel, for Key Equipment Finance. Bullen joined KeyCorp in 1992 as assistant vice president at Society Equipment Leasing/KeyCorp in Cleveland. In 1996, he became vice president, area sales leader, for KeyCorp Leasing, followed by promotions in 2008 to regional sales director for the Great Lakes Region and in 2009 to senior vice president and national sales manager, direct sales group. Prior to KeyCorp, Bullen was assistant vice president from 1989 to 1992 at Ameritrust Co. in Cleveland, which he joined in 1987 as a credit analyst. He can be reached at firstname.lastname@example.org or at 216-689-8579.