What Specifically Does The Business Need Financing For?
For equipment financing and leasing companies, the type of asset is critically important to getting past step 1 of the process. Outside of an individual private lender with cash in their own bank account, every single financing company gets their money from somewhere else, meaning they are also borrowers. This applies to every bank, mortgage company, trust company, asset based lender, etc.
These sources of money will many times dictate the types of applications for capital that a finance company can even entertain. If your proposed capital application does not meet the financing criteria of a financing company’s own capital provider, then the application cannot be considered.
For instance, many equipment financing companies will not consider applications for computer equipment, servers, office equipment, etc. That category of equipment does not make up part of their lending base.
Even when equipment to be acquired fits into a lender category, the lender will still assess whether they are prepared to hold the asset as primary security.
Equipment finance companies all have to answer the following question on every application they receive … “in the event that the applicant fails to make their payments, how do we get our money back?”
"In the event that the applicant fails to make their payments, how do we get our money back?"
For most lenders, equipment is considered as solid primary security IF 1) there is an established resale market for similar used items 2) where repossessed equipment can be sold into within a predictable value range and 3) within a predictable time frame.
In many cases, asset liquidation is done through auction services that sell significant volumes over time of the equipment in question. If a predictable resale liquidation pathway like an auction does not exist, then its less likely that the finance company will approve financing, or if they do, it will be for less favorable terms.
There are all sorts of other mitigating factors a finance company will consider to reduce their risk in these situations including but not limited to 1) utilizing other owned assets as security, 2) adding additional applicants, lessees, and/or guarantors, 3) entering into a third party remarketing agreement, 4) entering into a vendor recourse agreement, and 5) registering security against personal assets held outside the business.
But it all starts with their clear understanding of what you need capital for and what they can hold as security.
From their initial assessment, your application will either be 1) declined, 2) continue on under consideration for preferred terms, or 3) continue on under consideration for secondary terms.
Completing Step 1 is important to see if you have the potential to get approved and funded by the financing source you’ve initially targeted for terms you are prepared to accept, or if you have to move on to another financing source.
Continuing on with the equipment acquisition example, a capital request for equipment acquisition should be fully described with the following information:
Year of Manufacturing
Features and Attachments
Operational Performance Data if applicable
Standard equipment or customized (If customized, detail the customizations)
This provides key reference information to a lender so they quickly can determine exactly what the request for capital is for.
The age and remaining economic life of an asset to be acquired will impact a number of things in a finance company’s initial assessment of your application.
First, if the equipment is used, the application may be immediately declined if a finance company is only interested in financing new equipment.
Second, the actual age typically is assessed against predetermined age criteria which can be further established by classification of asset. For instance, a highway truck can fall under a “rule of 8” where the combined age of the truck and the proposed repayment term cannot exceed 8 years.
Other finance companies will have their own absolute rules that equipment in certain categories cannot be older than x years of age, regardless of how much or how little the equipment has been utilized.
Third, the remaining economic life is determined by a combination of age, mileage if applicable, motor hours if applicable, mechanical condition, etc. Similar to the rule of 8 mentioned above, a finance company needs to make sure that the estimated remaining economic life of an asset, for its intended use, will exceed the financing term that is being requested.
While some types of equipment can only be used in a very specific way for a very specific application, there are many types of equipment that can have broader types of usage. For instance, certain types of construction equipment can be used for all sorts of applications that may or may not have anything to do with construction.
Let’s consider the example of an excavator that can be used to move any type of material that has a physical form. If the application for use of an excavator related to some form of hazardous material handling, the use of the equipment could significantly reduce its value over time and make it a less desirable or preferred form of security. Further, if the excavator was financed under an equipment lease agreement, the lessor could be liable for remediation required on the equipment prior to it being resold in the future, further reducing its security value.
As mentioned in the previous section, intended use can also impact the estimate of remaining economic life. For instance, if a highway tractor is going be to run by 2 operators, 24 hours a day, 7 days a week, its remaining economic life may only be 3 years, even if it’s a new truck, which will impact the length of repayment time that a financing company is going to be prepared to extend for the equipment.
Location of Operation and Control
The location of operation is also a very important initial qualifying factor. For most financing companies, when it comes to equipment financing, are only interested in extending capital for equipment that will be located and operated in a jurisdiction where the finance company operates.
For instance, a Canadian equipment financing company is not typically going to finance an equipment purchase where the equipment is going to be located and operated outside of Canada.
The reasons are this are twofold.
Another country will have another legal system. This can impact establishing the proper registered security position, which likely going to be different in some way from what is required in the Canadian legal system. A different country’s legal system can also impact the legal process for both collections and reclaiming security to pay down an outstanding loan or lease account.
The location is also important if equipment is being used in doors versus outside.
If the equipment is being used inside, is it located inside an owned building or a leased building? Is it free standing on a floor or is it physically attached to the building?
For the first point, if it’s going to be located in a leased building, the lender will need to have a landlord waiver signed to provide access to the building. If access can’t be granted in writing, then the finance provider will not approve the deal.
On the second point, if the equipment is attached to a building, it can legally be considered to become part of the building and therefore could fall under the security of liens registered against the building. A financing source would need to have confirmation in writing that this was not the case, or they would not be able to approve and fund the deal.
For most financing companies, the equipment also needs to be controlled and operated by either the applicants or the employees or contractors of the applicants. If the equipment was intended to be lent or rented out to a third party, this would be in violation of the financing policies for a very high percentage of lenders and therefore they would not be able to approve and fund the deal.
" When there is a lack of specific and fully descriptive information, financial underwriters/officers will make assumptions to fill in the blanks which may or may not be beneficial to your application or request for business financing."
Origin of Supply
The origin of supply is another legal jurisdiction issue. If you’re looking to acquire equipment from a vendor in another country, the vendor in most cases will not ship the equipment until it’s paid for. So from a financing company’s perspective, until the equipment gets into the country they reside in, most equipment financing and leasing sources will not advance payments. Even if they do approve you, they won’t issue payment directly to the vendor until the equipment arrives in the final jurisdiction.
There are several ways to potentially deal with this type of scenario, but the important point here is that you can apply for financing or leasing, and get approved by a lender or leasing company, and never get the deal funded if you require the financing company to pay a vendor in another country prior to the equipment being shipped.
This becomes another important initial qualifying item when you’re targeting a financing source. Once this requirement is known, your application will not be considered further without some sort of mitigating factor acceptable to both you and the financing company.
Origin of Supply is also an important criterion for lender selection in the first place.
Terms of Sale
The most important term of sale is typically the payment terms…when does the vendor require payment and what has to happen before you take possession of the equipment?
Is the equipment in inventory and ready for sale, or does it need to be manufactured?
Equipment that needs to be manufactured may require 2 or 3 separate payments prior to shipping. From an application for financing perspective, can the finance company you’re applying to accommodate the payment term requirements, which could also involve issuing payments to a vendor in another country.
There can also be currency exchange risk to factor in and cover off.
There could be significant delays between when funds are paid and when the equipment is actually delivered and installed, which would likely create additional financing costs that may end up being different than rate in the base agreement.
Terms of sale are another first step qualifying process by a financing company to see if they can accommodate the vendors payment requirements. If they can’t, then financing will never get secure from that source.
So regardless of what type of capital request you’re making, it’s important to provide as much information as possible to fully describe what you need the money for so that a targeted financing sources can quickly determine if they can further consider your financing request.
In general terms, the “what for” can be described by broader categories, like real estate, equipment, working capital, share acquisition, debt consolidation, etc.
But variations of the “what for” are almost limitless which is why being specific is so important. When there is a lack of specific and fully descriptive information, financial underwriters/officers will make assumptions to fill in the blanks which may or may not be beneficial to your application or request for business financing.
Another reason why all the initial information is so important is because when formal applications exclude key information about a proposed capital application, the process may continue moving forward, and an approval may even still be granted with just the information provided. But eventually the missing information will be required, and at that point everything can grind to a halt if the finance company can’t get to a funding position.
I’ve seen company’s invest months into a business financing application, where an approval was granted, but funding never took place because the initial information package was incomplete and did not list out all the funding requirements.
The result was a massive waste of time.
There is this belief among many business owners and managers that if a financing company likes a deal and invests months going through the process with you, that they’ll find a way to get the deal funded when missing details come to light that impact the deal.
While that could happen, its unlikely, and I’ll explain why in the “Application Section”.
Just because something is possible doesn’t mean it’s probable.