In 2003, venture capitalists and investors dispensed over $18 billion to promising young U.S. companies, according to VentureOne and Ernst & Young Quarterly Venture Capital Report. Less documented and reported is venture leasing's activity and volume. This form of equipment financing contributes greatly to the growth of U.S. start-ups. Yearly, specialty leasing companies pour hundreds of millions of dollars into start-ups, permitting savvy entrepreneurs to achieve the biggest 'bang for their buck' in financing growth. What is venture leasing and how do sophisticated entrepreneurs maximize enterprise value with this type of financing? Why is venture leasing a cheaper and smarter way to finance needed equipment when compared to venture capital? For answers, one must look closely at this relatively new and expanding form of equipment financing specifically designed for rapidly growing venture capital-backed start-ups.
To help me understand why I was hearing the reluctance on the part of the leasing company executive, I began asking probing questions to determine if he felt our customer had not fulfilled the terms of the lease contract. I quickly confirmed that all the lease's provisions had been followed to the letter. The real problem was that the leasing company expected their leases to renew for at least one additional renewal term. The leasing company executive admitted that their business model incorporated them receiving the additional revenue of at least one renewal term. Their residual position (what they expected to receive by selling the equipment to someone else) was set expecting this additional revenue. If they didn't receive the renewal revenue, their profits were off (low) for that transaction.
I asked the executive how they could be so sure that equipment would go into renewal. Without hesitating, he answered because historically most of their equipment leases do. After getting up off the floor, I asked his opinion why that many leases went into renewal. He replied that it was either the lack of tracking the lease expiration or turnover in the customer position that was responsible for notifying the lease company in a specific time frame (designated within the lease agreement). The majority of copier leases are written for a 5-year lease term. Turnover (either promotions or by leaving) within a customer's business does usually occur before the end of the lease. In addition, during the course of busy days at the office, no one stops to document lease expiration dates. It seems so far away and therefore unnecessary at the time.
For the tenant, a blend and extend lease works in their favor by providing them with the opportunity to renegotiate the lease terms and oftentimes renew the lease with a less expensive monthly rent. The rent is not the only thing which the tenant can renegotiate in a this kind of lease. Rental abatement, options to renew, expand or contract and office space improvements are also negotiable points in the new and revised lease.
The primary reason you don't want your lease to renew is that you are being forced to pay new equipment costs (i.e. the same lease payment) for your old and well used equipment. In essence, you have no options. In contrast, if you don't get snagged by the lease renewal, you can always lease more highly featured and productive equipment for the same or lower cost. Another available option is to release your same equipment (assuming it has been working well) for a shorter term at a significant discount. There has been some backfiring of this intentional upgrading plan when customers are so infuriated by the renewal that they refuse to work with either the equipment vendor or the leasing company. As a result, there has been a softening of some of the stringent requirements. You have to check the verbiage in your current lease agreement in the section labeled something like "End of Lease" or "Renewal" to determine the expiration criteria.
Once the start-up finds a capable venture lessor, negotiating a fair and competitive lease is the next order of business. A number of factors determine venture lease pricing and terms. Important factors include: 1) the perceived credit strength of the lessee, 2) equipment quality, 3) market rates, and 4) competitive factors within the venture leasing market. Since the lease can be structured with several options, many of which influence the ultimate lease cost, start-ups should compare competing lease proposals. Lessors typically structured leases to yield 14% - 20%. By developing end-of-lease options to better accommodate lessees' needs, lessors can shift some of this pricing to the lease's back end in the form of a fair market value or fixed purchase or renewal option. It is not uncommon to see a three year lease structured to yield 9% - 11% annually during the initial lease term. Thereafter, the lessee can choose to return the equipment, purchase the equipment for 10% - 15% of equipment cost or to renew the lease for an additional year. If the lease is renewed, the lessor recovers an additional 10% - 15% of equipment cost. If the equipment is returned to the lessor, the start-up reduces its cost and limits the amount paid under the lease. The lessor will then remarket the equipment to achieve its 14% - 20% yield target. Another way that leasing companies can justify slashing lease payments is to incorporate warrants to purchase stock into the transaction. Warrants give the lessor the right to buy an agreed upon quantity of ownership shares at a share price predetermined by the parties. Under a venture lease with warrant pricing, the lessor typically prices that lease several percentage points below a similar lease without warrants. The number of warrants the start-up proffers is arrived at by dividing a portion of the lease line - usually 3% to 15% of the line - by the warrant strike price. The strike price is typically the share price of the most recently completed equity round. Including a warrant option often encourages venture lessors to enter transactions with companies that are very early in development or where the equipment to be leased is of questionable quality or re-marketability. Building a young company into an industry leader is in many ways similar to building a state-of-the art airplane or bridge. You need the right people, partners, ideas, materials and tools. Venture leasing is a useful tool for the savvy entrepreneur. When used properly, this financing tool can help early stage companies accelerate growth, squeeze the most out of their venture capital and increase enterprise value between equity rounds. Why not preserve ownership for those really doing the heavy lifting?
To help me understand why I was hearing the reluctance on the part of the leasing company executive, I began asking probing questions to determine if he felt our customer had not fulfilled the terms of the lease contract. I quickly confirmed that all the lease's provisions had been followed to the letter. The real problem was that the leasing company expected their leases to renew for at least one additional renewal term. The leasing company executive admitted that their business model incorporated them receiving the additional revenue of at least one renewal term. Their residual position (what they expected to receive by selling the equipment to someone else) was set expecting this additional revenue. If they didn't receive the renewal revenue, their profits were off (low) for that transaction.
I asked the executive how they could be so sure that equipment would go into renewal. Without hesitating, he answered because historically most of their equipment leases do. After getting up off the floor, I asked his opinion why that many leases went into renewal. He replied that it was either the lack of tracking the lease expiration or turnover in the customer position that was responsible for notifying the lease company in a specific time frame (designated within the lease agreement). The majority of copier leases are written for a 5-year lease term. Turnover (either promotions or by leaving) within a customer's business does usually occur before the end of the lease. In addition, during the course of busy days at the office, no one stops to document lease expiration dates. It seems so far away and therefore unnecessary at the time.
For the tenant, a blend and extend lease works in their favor by providing them with the opportunity to renegotiate the lease terms and oftentimes renew the lease with a less expensive monthly rent. The rent is not the only thing which the tenant can renegotiate in a this kind of lease. Rental abatement, options to renew, expand or contract and office space improvements are also negotiable points in the new and revised lease.
The primary reason you don't want your lease to renew is that you are being forced to pay new equipment costs (i.e. the same lease payment) for your old and well used equipment. In essence, you have no options. In contrast, if you don't get snagged by the lease renewal, you can always lease more highly featured and productive equipment for the same or lower cost. Another available option is to release your same equipment (assuming it has been working well) for a shorter term at a significant discount. There has been some backfiring of this intentional upgrading plan when customers are so infuriated by the renewal that they refuse to work with either the equipment vendor or the leasing company. As a result, there has been a softening of some of the stringent requirements. You have to check the verbiage in your current lease agreement in the section labeled something like "End of Lease" or "Renewal" to determine the expiration criteria.
Once the start-up finds a capable venture lessor, negotiating a fair and competitive lease is the next order of business. A number of factors determine venture lease pricing and terms. Important factors include: 1) the perceived credit strength of the lessee, 2) equipment quality, 3) market rates, and 4) competitive factors within the venture leasing market. Since the lease can be structured with several options, many of which influence the ultimate lease cost, start-ups should compare competing lease proposals. Lessors typically structured leases to yield 14% - 20%. By developing end-of-lease options to better accommodate lessees' needs, lessors can shift some of this pricing to the lease's back end in the form of a fair market value or fixed purchase or renewal option. It is not uncommon to see a three year lease structured to yield 9% - 11% annually during the initial lease term. Thereafter, the lessee can choose to return the equipment, purchase the equipment for 10% - 15% of equipment cost or to renew the lease for an additional year. If the lease is renewed, the lessor recovers an additional 10% - 15% of equipment cost. If the equipment is returned to the lessor, the start-up reduces its cost and limits the amount paid under the lease. The lessor will then remarket the equipment to achieve its 14% - 20% yield target. Another way that leasing companies can justify slashing lease payments is to incorporate warrants to purchase stock into the transaction. Warrants give the lessor the right to buy an agreed upon quantity of ownership shares at a share price predetermined by the parties. Under a venture lease with warrant pricing, the lessor typically prices that lease several percentage points below a similar lease without warrants. The number of warrants the start-up proffers is arrived at by dividing a portion of the lease line - usually 3% to 15% of the line - by the warrant strike price. The strike price is typically the share price of the most recently completed equity round. Including a warrant option often encourages venture lessors to enter transactions with companies that are very early in development or where the equipment to be leased is of questionable quality or re-marketability. Building a young company into an industry leader is in many ways similar to building a state-of-the art airplane or bridge. You need the right people, partners, ideas, materials and tools. Venture leasing is a useful tool for the savvy entrepreneur. When used properly, this financing tool can help early stage companies accelerate growth, squeeze the most out of their venture capital and increase enterprise value between equity rounds. Why not preserve ownership for those really doing the heavy lifting?
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Frank Miller has a Debt Consolidation Blog & Finance, these are some of the articles: The 3 Strategies To Finding Hard Cash Lenders To Provides Funds For Your Real Estate Offers You have full permission to reprint this article provided this box is kept unchanged.
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