GROWTH PARTNERS. Funding. Leasing Finance

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1 GROWTH PARTNERS Funding Leasing Finance

2 Benefits More equipment is financed today by leases than by bank loans, private equity or any other method of asset financing. According to The American Association of Equipment Lessors, approximately 80% of all American companies including the Fortune 500 currently use leasing each year to acquire in excess of US$300Bill capital equipment. Leasing is a versatile financial instrument which allows for almost any asset that can be purchased to also be leased from: computers surveillance motor fleets office automation generators heavy duty equipment security systems renewable energy and even satellites More and more, financial decision-makers are recognizing that earnings (returns) are derived from the use of an asset and not from the actual ownership of that asset. Capital is a valuable commodity, and in most circumstances, the benefit from investing into one s own working capital, into corporate activity (acquisition) or a class of asset that appreciates derives an exceeding return than the actual cost of leasing. In essence, leasing is simply an alternate method of financing. The reason for widespread adoption of leasing is due to the following benefits: LIQUIDITY (NIL deposits, eliminates cash flow spikes of upgrades/refresh) SAVINGS (Vendor discounts, tax deduction, inflation hedge and NIL fees) CAPITAL PRESERVATION & ROI (preserves capital for ROI whilst realising tech benefits upfront) VALUATION & GEARING (off-balance sheet funding improves valuation & gearing ratios) CONVENIENCE (payments matched to savings/productivity derived over assets lifecycle) ADMINISTRATION (reduced admin & auditing work with no matching of wear & tear nor re-valuations) FLEXIBILITY (leases tailor-made to suit budgets & cash flows and include intangible costs) DECISION-MAKING (enhances decision-making & adoption time within corporate governance) RISK REDUCTION (mitigates obsolescence risk & vulnerability to single credit-line) TRANSPARENT (NIL Fees, NIL Escalations, NO Full settlements, NO Evergreens) ENTREPRENEURIAL (a professional, personal, service-driven, managed approach)

3 Leasing vs. Cash and Traditional Bank Finance (HP)_ Far too often, one sees organisations purchasing the required equipment for cash and subsequently experiencing liquidity constraints or an inability to fund their actual working capital or business growth, as their capital has been tied-up/sunk into depreciating equipment assets. It is a fact that businesses are sometimes profitable when forced to file for liquidation as a result of poor cash flow management. An organisation should earn a higher return on the cash they would have spent on equipment assets when that same valuable cash is invested in the core operation. The effective return on working capital should outweigh the effective cost of the lease (after tax interest rate) so using the leasing option would make the acquisition of the equipment a positive NPV project. Banks offer finance leases and instalment sale agreements that are traditionally geared to the wheels business and don t appear to have a mature view of the tech market and its respective industry risk. Bank funding typically taps your existing credit line (marked for working capital) which in-turn can crimp your capacity to grow operations. Banks look to secure their lending in taking an asset view (margining the loan-to-value with deposits etc.) and generally don t have an appetite to fund software & installation ( intangible ) costs. Banks normally charge fees separate to the prime rate which include initiation, document, service and collection fees to boost their non-interest income. As commercial institutions, Banks are heavily regulated thus would battle to offer the commensurate structuring and service as well as the flexibility in upgrade, settlement and end-of lease procedures.

4 Background A lease is a contract between two parties being the lessor ( the owner or rentor ) and the lessee ( the user or hirer ), whereby the lessor permits the lessee the right of exclusive use of an asset in exchange for the commitment to service a series of lease payments, over the term of the lease. At the end of the initial lease term, the lessee may have the option to renew or extend the lease, buy the equipment (for a nominal or residual value) known as a bargain purchase option, or to terminate the agreement and return the equipment. This end-of-lease option is important to determine the nature of the lease for tax purposes as well as the disclosure of the lease for financial accounting purposes. It is common practice for vehicles and office equipment to include maintenance and/or insurance, known as full-service/maintenance leases. Alternatively, where the lessee is responsible for such expenses, the lease is known as a net lease. Leases come in many forms; commonly traded leases in South Africa are known as Rental or Operating Leases or Finance Leases. Leases are flexible instruments of finance as they may be tailor-made for the client in terms of: the variable duration of the lease, allowing for lower initial lease payments with an annual escalation, no or partial deposit, monthly or quarterly frequencg of payments, variable or fixed payments, and even incorporating a residual value to lower repayments. Residual value-based leasing products are becoming more popular particularly in the motor-industry, driven by the increased competition within the finance industry and also requirements to maintain the classification for accounting purposes. Normally, in order for the lessor to enter into a RV-based lease, due to the unknown risk in calculating the recoupment value of the asset on maturity of the lease, there will either be a secondary sale or lease program in place, or a manufacturer buy-back scheme, or insurance taken out to guarantee the RV. Sale and leaseback involve the transfer of risk of an existing fleet with the option of renting the vehicles back to the customer and provides for the benefit of a fully-maintained and managed fleet and possible cash injection for the client.

5 Classification The classification of a lease is determined by the extent to which the risks and rewards incidental to ownership of a leased asset lie with the lessor or lessee. The International Accounting Standard 17 for Leases (IAS 17) states A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operational lease if it does not transfer substantially all the risks and rewards incidental to ownership. Hence, the classification and accounting treatment of a lease will be determined by the terms of the lease and as such whether it needs to be capitalized onto the balance sheet or simply disclosed as an operational cost in the period incurred, and it is classified at the discretion of a company s auditors. Summary In summary, corporate financial executives are recognizing that earnings are derived primarily from the use of a movable asset, and not the actual ownership of that asset. Also, whether an asset is owned or leased has no material impact on the operation of the business. Hence the phrase that was coined buy what appreciates and lease what depreciates. a society becomes great when old men plant trees whose shade they know they shall never sit under ~ A Wise Man