When purchasing fixed assets there are alternatives to bank funding. Some of them offer a number of benefits over a conventional loan.

In this chapter, three things that really matter:

• ˜ Using hire purchase
• ˜ Considering leasing options
• ˜ Gaining a commercial mortgage

In Chapter 1 we looked at the importance of gaining the right mix of funding. When purchasing fixed assets your options are greatly increased. There are a number of finance companies in the funding market that specialise in asset finance. In many ways, this sort of finance is easier to obtain than bank funding. This is because the asset that you are purchasing can effectively be used as security for the debt.

This can be both an advantage and a disadvantage. If you are winding up your business on a voluntary basis it gives you the option of returning the item as being no longer required. If, on the other hand, you are experiencing financial difficulty, the removal of the asset could bring about the downfall of your business.

As a prime example, consider a new start-up sole trader in business as a taxi driver. Funding the vehicle on hire purchase or leasing would probably be one option. Stop making the payments, however, and the prime asset of the business, absolutely essential to keep the business running, could be repossessed. This would inevitably lead to total failure of the business.

Is this you?

Hire purchase is the cheapest option, I can easily get one of those interest free deals. • Lease purchase is just the same as leasing, isn’t it? • Leasing is no good to me, I’ll never own the asset. • Why should I even think about using a building society, they only lend to people who want to buy a house.

Using hire purchase

Hire purchase can be a very easy financing option. It is also sometimes referred to as lease purchase although it is not the same as leasing. You only have to walk down your local high street to see the range of hire purchase schemes that are available, some more expensive than others. Hire purchase is an agreement to buy an asset, for example, a motor vehicle or computer equipment, with defined repayments over an agreed term. Depending upon the agreement, ownership of the asset may, or may not, pass to you immediately. Some agreements, for obvious reasons, do not allow ownership until all instalments have been paid.

In accounting terms, however, the asset is treated as yours and as such it will appear in your balance sheet. This can mean that capital allowances and the interest portion of the repayment are available to offset taxation. You will need to seek specialist advice on this aspect from your accountant.*

The disadvantages of hire purchase are the same as if you bought the asset outright. If it breaks down, unless it is under guarantee, you will be responsible for the repairs.

• ˜ If, for example, you buy a motor vehicle on hire purchase, you are responsible for the costs of maintenance.

Breaking the agreement by returning the asset early voluntarily can also involve penalties. The hire purchase agreement is for a defined term and the finance company will price the cost of repayments based on the whole term. Hire purchase can sometimes be cheaper than traditional bank finance. This is often the case where the manufacturer of the product also provides the finance to make a purchase. Hire purchase can also be more expensive.

• ˜ You need to check and compare the APR carefully before you sign the agreement.

This is a very important aspect. Sometimes the ease with which the finance can be gained is not necessarily in your favour. As an example, some of the high street stores offer what seem to be very good financing deals with delayed repayments, sometimes for 12 months. If you look carefully at the agreement, however, you might find that the actual APR equates to around 30% per annum. This is definitely not a good arrangement for you to sign.

Considering leasing options

Leasing is an extremely flexible form of funding. A lease is negotiated with the lessor who acquires the asset that has been chosen by the lessee. Assets that can be leased are wide and varied. Photocopiers, computer systems, office furniture, motor vehicles, machine tools and heavy plant and equipment are all examples.

Leasing should be distinguished from hiring. Hiring requires the user to select an item from stock already held by the hirer. Leasing enables the lessee to select any item from any manufacturer or supplier. The choice is therefore unlimited. The leasing agreement will therefore be tailor-made for the actual asset involved.

There are three types of lease:

• ˜ Finance lease
• ˜ Operating lease
• ˜ Contract hire

With a finance lease, the lessor pays for the asset and becomes the owner. The lessee then pays a rental which covers the capital cost of the asset, together with interest and service charges. The purpose of this type of lease is solely to provide finance to the lessee on the security of the asset. The lessee is responsible for all maintenance and insurance.

Operating leases are mainly undertaken by manufacturers of products that tend to be highly specialised or technical. The lease usually provides that the lessor is responsible for servicing, maintenance and updating of the equipment.*

Contract hire is similar to an operating lease. One of the most common uses of contract hire is to finance a fleet of motor vehicles. In this case, the lessor takes responsibility for the regular maintenance and servicing of the vehicles. The lessee merely has to consider the day-to-day fuel costs.

Leasing provides a number of advantages over other forms of finance:

• ˜ The lessor retains ownership of the asset and, using the asset as full security, a more competitive finance cost may be available.
• ˜ The lease is for a fixed term and, whilst the leasing payments are being made by the lessee, the facility cannot be withdrawn unlike bank facilities which are usually repayable on demand.
• ˜ Apart from an initial advance monthly or quarterly payment, leasing does not involve any capital outlay.
• ˜ The lease can be flexible and in some cases the rental payments can be adjusted to take account of seasonal variations in trade.
• ˜ The income generated by using the asset in the business should make the costs of leasing self-financing.
• ˜ There may be tax advantages in that the whole costs of leasing can usually be offset against taxable income.

There are also disadvantages to leasing:

• ˜ As a start-up business it can be very difficult to obtain lease finance.
• ˜ Leased assets cannot be used as security for any other type of funding – the asset is not yours.
• ˜ There may be restrictions on the use of the leased asset and the lessor may insist on approving your insurance arrangements.
• ˜ Because the asset is not yours, you are not entitled to any residual value in the asset after it reaches the end of its working life.
• ˜ There is no entitlement to claim capital allowances for taxation purposes.

Taxation issues can play a large part in the decision whether or not to use leasing. You need to examine the financial, and indeed, the non-financial factors, before you make any decision. Seek the advice of an accountant or a tax specialist to define the effects that lease finance options will have on your business.

Obtaining a commercial mortgage

With the traditional differences between banks and building societies being eroded by a competitive market, more and more financing options are available. This is even more evident now that some of the building societies have lost their mutuality and effectively converted to banks.

Among these is the long-term lending by building societies to commercial customers. Commercial mortgages are, in effect, the same as mortgages available to personal customers. They are, therefore, only available if you are considering the purchase of premises.*

Traditionally a bank will offer anything between 45% and 70% of the total cost of the property. In addition, the value that the bank places on the property may be based on a forced sale basis rather than an open market valuation. In simple terms, the differences between the two are:

• ˜ Forced sale valuation – the price that the bank expects to achieve after all costs of sale and based on the principle that the property will be offered at a price to achieve a sale in the short-term.
• ˜ Open market valuation – the price that could be achieved in the market without undue time pressure on the sale being made. It is also calculated before the costs of the sale are deducted.

Building societies, on the other hand, are usually much more flexible. They will generally lend between 60% and 90% of the open market value although in some cases they are prepared to finance 100% of the total cost of the property. Each proposition is taken on its merits.*

The interest rate charged on a commercial mortgage can also be substantially lower than that charged by a bank. In some cases you could be able to negotiate an interest rate as low as 1% over base rate. In other cases the rate could be linked to the London Inter Bank Offer Rate (LIBOR), which can also be cheaper. You will, however, need to check the terms of the mortgage as to when the interest is actually charged to the loan. This can affect the APR which may in true terms be substantially more than the interest rate quoted.

A further example of the flexibility of a commercial mortgage is where repayment of the capital sum is deferred until the end of the loan, and interest only is repayable in the meantime. These are referred to as bullet repayment terms, and the loan can be repaid at the end of the term by a variety of means. These can include sale of the property, repayment from pension or life assurance proceeds, or any other secure method acceptable to the lender.

Summary points

• * Purchasing an asset gives you a number of alternative sources of finance – take time to check all of your available options.
• * Make sure that you always read all the terms and conditions of any agreement before you sign it – look for any penalty clauses.
• * Check carefully the Annual Percentage Rate (APR) that you are being charged – it can differ substantially from the interest rate quoted.