In recent years there has been a significant growth in the use of more alternative forms of business finance to acquire high-value equipment (e.g. machinery, computer systems, vehicles). Among these, asset finance has arguably become the most prevalent, with asset finance companies in 2017 alone providing more than £32 billion to UK businesses in the form of asset finance. Particularly with SME’s, there has been a surge of businesses choosing to use asset finance instead of purchasing equipment outright.
Asset finance is relevant for any business of any size which is considering purchasing high-value equipment needed to support their continuing growth. In addition, asset financing is very useful for a business who is unable to raise the funding needed to purchase such equipment outright or would like to the spread the cost the equipment (asset) over its usable life. Asset finance is also suitable for all business structures including Limited Companies, Sole Traders, Limited Partnerships, Public Limited Companies.
Pros
Significantly reduces the upfront cost
Asset finance lends itself particularly well to significantly reducing the large upfront costs associated with large capital purchases (such as equipment). This is because instead of a business buying an asset outright in cash, the asset finance provider will purchase the asset on the business’s behalf (shouldering the upfront cost) and then lease to the business for a regular usage payment.
Avoids deprecation
Many types of asset suffer from radical depreciation over a relatively short time frame (i.e. such as industrial machinery, commercial vehicles and information technology systems).
Depreciation quickly reduces the value of the asset and thus the security for the business (it’s unlikely a business can recoup near its original investment if the asset has to be sold). Many assets can lose close to third of their value even after the first purchase day, as they become labelled second-hand equipment (a good example of this is vehicles, in particular, cars). If the asset does not last as long as expected and depreciation is more rapid, it can also create a serious cost implication for the business (needing to pay for a replacement earlier than planned).
Asset finance alleviates the risks associated with depreciation as in most cases the business is not the owner of the asset, the provider is the owner and thus takes responsibility for bearing any unexpected loss in value or replacing the asset as needed (if it fails to survive the duration of the agreement).
Free capital
By avoiding large upfront purchasing costs, asset finance frees up businesses to redeploy capital elsewhere. Businesses get the best of both worlds, getting the use of needed assets but without the initial capital commitment, making available funds to support other growth activities or be kept aside for security, flexibility or to take advantage of future growth opportunities that require investment.
No unexpected costs
Asset finance providers are responsible for any management, maintenance and disposal concerning the asset (depending on your agreement/type of asset financing used). This protects businesses from any unforeseen costs required to keep the asset running or dispose of it.
Additional credit line
Asset finance can act as a useful additional form of credit for your business, when you’re unable to or don’t wish to extend existing facilities such as bank loans and overdrafts (in particular with allowing you to avoid the typically higher interest rates associated with overdraft and commercial loan products).
Little or no security required
If a business is in immediate need of high-value equipment critical to growth, doesn’t have the retained funds and can’t access the traditional forms of finance needed to make the purchase, asset finance can help.
In most cases, the asset is enough security for the asset finance provider to sign off on providing the financing (in some cases deposits are required though). Where traditional lenders are unable to assist, asset finance offers a secure way for a business to attain the asset they need while giving relatively security from ownership to the financier.
Improve your cash flow
For most types of asset finance, a business will make regular structured payments throughout the usable life of the asset. This allows businesses to spread the cost of the asset throughout its usable life as a result, improving cash flow and increasing the amount of working capital available at any time. With many such financing agreements a business can also agree with a provider to fix interest rates, dispensing with any unpredictable costs from an increase in rates).
Cons
Lack of ownership
Asset finance provides no long-term ownership of the asset to the business. This is opposed to more traditional financing options such as a commercial loan, where you would borrow money to purchase a high-value asset and in doing so gain ownership of the asset.
Asset finance means you are leasing or renting the asset (continually paying to use an asset), gaining no ownership of the asset in exchange for the payments you’ve made (unless otherwise agreed, i.e. a buyout or ownership transfer option at the end of asset life). The lack of ownership means the business won’t be able to sell the asset if needed to raise funds or use it as security to gain other financing. Thus, asset finance in reduces the flexibility and security the business receives from the asset.
Not a short-term financial solution
Asset finance is designed to work for longer periods; this enables the financier time to recoup the original cost of the asset purchase plus interest. For this reason, asset financing agreements are rarely agreed to for less than a year and in most cases much longer.
Thus, there is not really any short-term asset finance available. For those businesses who are seeking short-term working capital, asset finance isn’t an option.
Accidental damage may not be covered
Many asset finance agreements will cover maintenance costs and management (including general maintenance), but depending on the agreement in many cases damage to the asset that is deemed as accidental or preventable is not covered by the financier and instead the onus is put on the business leasing the asset to pay for any repair for replacement.
Summary
Asset finance depending on the business circumstances can offer a significant amount of advantage over more traditional forms of finance (typically in large asset/equipment purchases), however like any other forms of finance it has its disadvantages and limitations. It’s important to do your research and seek professional advice before you commit to an asset financing agreement or facility.
Case Studies
To give some further context to understand asset finance, b elow you’ll find three further working examples of asset finance:
- A large FMCG (Fast Market Consumer Goods) company requires a new fleet of vehicles to enable its growing regional sales teams to travel during business hours. The company does have the funding available to purchase a new fleet of vehicles but prefers to avoid the initial purchase cost and the associated management/maintenance fee. They enter into an asset financing agreement with their bank to rent the fleet of vehicles they require, the bank, in turn, purchases the vehicles and rents them back to the company for a period of 3 years. The bank is responsible for management and maintenance fees, the resulting freed up capital allows the business to invest in other areas of the business to support growth.
- A small manufacturing business who has recently expanded its client’s base outside of Europe is facing unexpected demand and requires finance quickly to purchase a new plant and equipment needed to meet the increased demand. The manufacturing business has currently little or no funding in reserve to purchase the needed equipment but wish to gain the benefit of having the equipment now and spread the cost of the equipment over its usable lifespan. The business does not have any major assets to act as security but presents its plan and the current demand situation to the financier. The financier agrees the growth and demand are promising and approves the asset finance deal over 48 months. The financier uses the equipment they will purchase to lease to the business as the security for the agreement. This allows them to quickly approve finance to a promising company in a growth situation where traditional lending or asset lending products would likely have not been authorised, due to the lack of collateral the business could provide.
- A coach travel business requires vehicle asset finance to free up capital from their fairly new fleet of vehicles (coaches). This capital will be used to take advantage of an unexpected opportunity to purchase a competitor at a lower than market value price. They decide that a business loan would be too much of a risk in financing the deal (given the high-interest rates). In order to move forward and finance the deal they agree with a commercial asset finance company to sell their fleet of vehicles to the financier and lease back the vehicles for the remainder of their usable life of 72 months (longer than the traditional type of asset finance but this can happen when assets have a long-life cycle). This is called asset refinancing; it allows a business to quickly free up capital stuck in an existing asset while retaining use of the asset.
