A perennial business question is: “How do you grow our business without unduly undermining the company’s capital reserves, thereby restricting options to take advantage of future expansion opportunities?”

The answer is surprisingly uncomplicated.
One of the most simple, yet flexible solutions to finance required plant or equipment acquisitions crucial to business growth, is utilisation of an operating lease or rental program.

What is an operating lease/ planned rental agreement (PRA)?
An operating lease/PRA is a flexible and practical option to acquire (leading edge/most technically advanced) plant or equipment of your choice, without capital drain or risk of ownership. Unlike other lease programs, there is no residual value/end balloon obligation at the end of the lease/hiring period. At the end of lease/rental period, the user returns the equipment to the financier, subject to pre-agreed maintenance conditions.

Operating leases are ideal for use by:
• Balance sheet-driven companies (ROE, ROI, P/E targets).
• Companies focusing on core activities.
• Companies with budget or capital expenditure constraints.
• Government entities.
• Australian entities with an offshore parent company.
• High growth companies.
• Entities with mid/short term contracts with contractual requirements for new equipment.

Accounting issues
All agreements must comply with Australian Accounting Standard AAS17.

A compliant operating lease is one where the lessor carries all the risk of ownership, while the lessee/renter enjoys the possession and use of the asset in carrying out their business during the term of the agreement. There can be no implied transfer of ownership of the equipment from the lessor to the lessee/renter at the termination of the agreement period.

A précised assumption on compliance with AAS17 is that the agreement must be cancellable, or if non-cancellable it should pass the following tests:
• The lease/rental term should be for less than 75% of the effective life of the asset.
• The present value of the lease payments at the beginning of the agreement should be less than 90% of the fair market value.
• There is no transfer of ownership from the lessor/financier to the lessee/ renter of the asset at the end of the agreement period by way of contractual obligation.

Independent accounting advice should be sought regarding compliance before entering into any contractual agreement with regard to operating leases or rental agreements.

In an operating lease, the lease payments are fully charged by the lessee as an expense and the payment disclosure in the statutory accounts. Future payments are not included in the lessee’s balance sheet, but disclosed in the notes to the accounts. This effectively removes the financing from the lessee balance sheet.

How does it work?
Operating leases/rental agreements involve a number of stake holders. It is here where MHF can apply its expertise to ensure that the lessee/renter gains the best financial solution available.

The key stake holders in an equipment acquisition transaction are:
• Asset purchaser (lessee/renter).
• Asset provider (lessee’s choice).
• Finance broker & transaction co-ordinator.
• Lessor (financier).
• Residual risk guarantor.

MHF acts as a catalyst to create the best outcome for all parties. When choosing and approaching the finance provider (usually a bank) and the residual risk guarantor, MHF will ensure they have obtained all the specifications for the equipment required and they each understand all the usage parameters. This will include the potential kilometres travelled, or the engine hours per annum, and other relevant measures to ensure the best residual value possible.

The residual value may vary by type of equipment or plant and takes into account the environmental factors that may affect it including corrosive atmosphere, dirt, surface etc.

Armed with this information, MHF can negotiate the best residual value. As the residual value is the single biggest factor in the equation, it is important to achieve the lowest lease/rental payments against the best residual value.

Residual risk guarantor – how does it work?
MHF works with a select number of residual guarantors, generally major bank/major financier owned.

These guarantors make a commitment to purchase the asset/s from the finance provider at an amount guaranteed at the outset of the transaction, provided that the assets have been maintained in accordance with the terms & conditions specified in the lease/rental contract. The residual guarantor then has the right to on-sell these assets into the secondary market at ‘fair market value’.

Having an involvement with all stake holders from the initiation to the conclusion of these type of agreements, MHF can become a strategic player in the negotiations between all parties in the sale, disposal or re-financing of the assets.

Benefits for the renter
Utilisation of operating leasing delivers many benefits to the renter. Not the least of which is that it eases strain on working capital by providing 100% finance on incomeproducing assets. It can also provide a mitigating buffer on the lifecycle cost of production/utilisation and technical advancements, as under certain agreements, equipment can be added to, upgraded or down sized during a contract.

Rental transactions are generally treated as ‘expense’ items and this may give rise to benefits from taxation and balance sheet considerations, although accounting advice should be sought to determine these issues. An additional option is also to structure a flexible repayment program, whereby the asset’s profitability return can be directly matched to the rental payments.

By using an operating lease, you can afford the latest and the best and save. You won’t get locked into old technology and can speed your adoption of new technology. During the lease it is possible to roll in technology upgrades, which will keep your business using future and cutting edge technology.

Equipment types suitable for operating leases
Operating leases can be applied to a wide range of materials handling plant and equipment.
• Automatic storage and retrieval systems (ASRS).
• Total integrated logistics solutions.
• Picking and sortation solutions.
• Cargo and general materials handling equipment.
• Containers.
• Container cranes.
• Trailers.
• Storage sheds and re-locatable buildings.
• Distribution equipment (fork trucks, etc).
• Industrial and robotic equipment.
• IT solutions including software and hardware.

Equipment suppliers benefit, too
Using an operating lease/rental agreement is a good way to secure orders even if the customer does not have the capital at that point. This is real a win-win situation.

The supplier will be notified directly by the lessor (financier) that the transaction is approved. If it is a large system that is being implemented, then with agreement between the lessor and the lessee, payments to the supplier can be programmed to meet milestones and the interest on the payments can be capitalised to be taken out by the operating agreement, thus the lessee/renter only pays when the system is complete.

MHF track record
MHF fields an experienced finance and business team led by directors Ian Ogilvie and Peter Somerville.

Ian Ogilvie has vast experience in building automatic storage systems, from rack-clad hi-rise with cranes to mini-load systems and general picking and automation systems in Australia and South East Asia.

Peter Somerville worked as a commercial business banking manager for 10 years before joining MHF. He brings enormous commercial banking experience to the team. Peter specialises in high-growth companies requiring total structured finance solutions.

MHF’s Structured Asset Finance consultant, Russ Brady, is ex-Commonwealth Bank (40 years). For the last 12 years he was Queensland manager SAF, providing finance solutions for institutional and corporate clients. Russ has had years of experience and success in providing financial solutions in the acquisition of major capital assets, including warehouse distribution and logistical support, shipping and port handling equipment, heavy mining and construction vehicles, and fleet acquisition and management

Materials Handling Finance has recently brought to a successful conclusion the financing of a $26 million, progressively funded operating lease for the acquisition and installation of two automatic storage and retrieval systems. This entailed the coordination of the several major parties involved in the transaction, the acquiring company, the equipment and system supplier, a major Australian bank as lender and Australian Asset Residual Management as residual guarantor. One system is located on the client’s company-owned property, and the other on a leased property.

The agreements were drawn up adhering to Australian and overseas accounting standards, and keeping a potentially complex transaction uncomplicated. Involved in these systems were hardware, racking, cranes, software, and conveyors, which were bundled up for this transaction.

Operating leases can start as low as $250,000. MHF also has many other flexible finance products to suit businesses. These include construction finance, industrial and commercial buildings, other equipment finances, and other debtor financing solutions.

For more information contact Ian Ogilvie, Peter Somerville or Russ Brady at MHF on 1300 884145 or email iogilvie@mhf.com.au.


*Excerpt from MHD Supply Chain Solutions May/April 2008, pp.16-7.

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