The Funding Conundrum

Business people look long and hard at their choices before acquiring an expensive piece of equipment for their companies. Price, quality, ROI, level of technology, and durability figure into their decisions. The size of its footprint may be pondered, as well as the learning curve for its future operators.

But once the equipment has been chosen, another crucial decision remains: What financial arrangement to use. Whether you decide to buy or lease, a range of options awaits. You'll need to choose carefully based on the particulars of your company's situation, including cash flow, taxes, long-term equipment needs, and technology changes. One arrangement could cost you far more in the end than another, or could preclude later equipment upgrades necessary to stay competitive.

What follows is a general exploration of the options that may be available to small and large jewelry companies — depending on their financial standing and track record. Every company's situation is unique, and big-money purchases should be guided by an accountant or financial adviser.

Covering All the Bases: Vendors as a Financial Resource

Equipment vendors have a strong interest in seeing you obtain the money needed to acquire their goods. They may be your most helpful resource — either of affordable financing through a captive arm or by directing you to outside companies offering good terms.

For example, Solidscape Inc. in Merrimack, New Hamp-shire, doesn't finance purchases or leases of its rapid prototyping systems and other equipment, but refers customers to Sunbelt Lessors, with which it has an established relationship, says marketing manager Bruce Lustig.

Crafford — LaserStar Technologies in Riverside, Rhode Island, has gone even further. It created LaserStar Leasing Services, which educates customers about their options and can set buyers up with one of two major lenders. James Gervais, executive vice president of Crafford — LaserStar, emphasizes that "they're lend-ers, not brokers. The customer gets the best possible deal. There's no middle man getting points and no confusion."

"The [customer] doesn't have to shop around," Gervais adds. "We did it for them, and they can rely on our relationships."

The Purchase Puzzle: Paying Cash vs. Borrowing

When you write a check out of the company account to buy a piece of machinery, the goods are yours — no interest payments, no leasing fees, and full depreciation benefits. But, as Gervais notes, "over the years the ability of new potential buyers to make cash outlays for purchases has diminished."

And even if a company has the cash, it may still make better sense to borrow the amount needed. If used for other purposes, a company's cash resources may generate a return higher than the cost of borrowing and allow greater overall investment. Other pluses include the same depreciation write-offs and potential state incentives that a cash purchase would enjoy, and a predictable payment schedule, though variable-rate loans create some interest-rate exposure.

There are potential downsides, too, in the company's reduced borrowing capacity as well as this aspect of any equipment purchase: After you've bought it, you're committed, even if it breaks down or a far better version appears in a year or two.

If you decide to borrow, the key issues are which source and what terms.

Banks and other commercial lenders. Traditional sources of financing, they offer the standard benefit of business borrowing: You get the money you need to grow your company. But negatives include the likelihood of a required 10 to 20 percent down payment, dealing with an institution that may be unfamiliar with the workings of your industry, relatively rigid lending terms and standards, and, as with any lender, in-terest payments.

Finance companies. According to the U.S. Small Business Admin-istration (SBA), finance companies have become the second-biggest credit source for small businesses. Among their advantages are greater flexibility on terms, quick turnaround on approval, and greater willingness to fund specialized equipment and offer longer terms. The biggest negative is cost: Finance companies typically charge far higher interest rates than banks.

Private lenders. David Newton, professor of entrepreneurial finance and head of the entrepreneurship program at Westmont College in Santa Barbara, California, says private lenders — loosely defined as institutions or individuals that provide funding in the form of debt, often through brokers — are also not as rigid as banks and offer an opportunity to negotiate more favorable terms.

"When it comes time to negotiate everything, business owners are in a much better position dealing with a private lender than with a commercial or community bank," Newton writes. "Many private lenders ask for significant concessions from the borrowing firm and can present these in a manner that makes them appear to be set in stone. All lenders — whether commercial or private — want to minimize risk exposure, but the [borrower] should see this as an opportunity to make a presentation that demonstrates the numerous reasons why this loan will not be at great risk."

Federal, state, and local government loan programs. From the U.S. SBA to local economic development agen-cies, myriad government bodies exist to help businesses grow and pros-per, often with low-cost guaranteed loans. Lend-ing requirements may be strict, and programs often focus on job creation, but you'd still be remiss if you failed to check out what is available.

Seller-carried paper. Newton suggests this approach for the acquisition of used but well-maintained equipment from another manufacturer that no longer needs it. In his example of a five-year deal, the seller would agree to carry the deal at a low interest rate, and the buyer would negotiate a payment stream for the first 18 months based on the equipment's manufacturing output. That could preserve cash while the buyer integrates the equipment into its operations. The buyer would make a fixed monthly payment for the last 42 months as well as two balloon payments, and also pay for shipping and paperwork.

Even with the secondary costs added in, Newton says, the buyer would still pay far less for the used equipment — perhaps 40 percent less — than it would for a new machine. The seller would benefit by getting the equipment out of its plant and recouping some of its original cost.

Leasing: Variations on a Financing Theme

Lease-finance operations may offer a multitude of options. In an operating lease, the equipment is rented for a fixed period of time and then returned. A finance lease, or capital lease, gives the renter the choice of purchasing the equipment at the end of the contract. Sometimes that re-quires making a balloon payment. At Crafford — LaserStar, Gervais says, finance leases are structured for tax purchases to allow purchase at a nominal $1. Depending on the financing company, some leases may enable early buy-outs that convert the lease to a loan. Other terms require the seller to handle maintenance or allow a "skip-payments" option, which postpones payments until the equipment is generating revenue.

Whether leasing is the best choice or not depends on your situation. If you expect to need the machinery beyond the term of your rental, fees might eventually exceed the purchase price. But if the technology is likely to change quickly, a short lease might allow you to up-grade when you need to. Bor-rowing capacity and cash are conserved, but tax considerations and later cash flow effects should not be ignored. Among other things, you may lose the depreciation.

With that many financing choices and variables, it is imperative that buyers do their homework and get good advice. On a $10,000 or $100,000 deal, what you don't know can cost you dearly.