Equipment Acquisition Strategies

Sept. 1, 1999

When it comes to excavation and grading, you usually have to have big and expensive tools to do the job. There are basically three acquisition options open to you: You can buy, you can lease, or you can rent the equipment.

Almost all equipment manufacturers run their own financing services that make it easy and attractive for the customers to do financing through them. They can offer highly competitive rates and the attendant benefits of acquiring equipment through the manufacturer, thus reinforcing the client/provider bond.

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In addition to the traditional financing options offered by manufacturers, most of them also provide equipment leasing services. In fact, eight out of 10 companies lease some or all of their equipment, and the number of financial institutions and independent leasing companies is growing steadily—it’s a $180-billion-a-year industry according to the Equipment Leasing Association.

There is also the rental business. With over 12,000 rental centers already operating in the United States and Canada and many more projected to open in the next few years, it’s a business that has really taken off in the last decade. More and more contractors are using rentals as their primary source of equipment acquisition and to meet specific equipment needs on projects.

I Want to Buy

There are thousands of banks, loan companies, and independent financing companies willing to provide the capital to meet equipment purchases, and most manufacturers provide financial services through captive financing companies. What should you look for in selecting the right purchasing finance for your particular needs?

You want the best deal, of course, but lower interest rates are just part of the picture. Financing through the manufacturer’s captive finance company will give you access to lower interest rates because they are subsidized by the manufacturer. Another advantage to doing business this way is that captives know their customers and the equipment better than an outside agent does—after all, they’re lending on assets they know. They might also prove to be more flexible in the even of skipped payments or token payments at certain times of the year because they know the environment in which you are working.

But probably the biggest draw is the level of service they can provide. Because they work through the equipment dealers, you’ll be talking to someone who probably knows you and knows your equipment needs well.

Grading & Excavation Contractor asked several key players in the construction-equipment financing and rental sector what their take on these issues is. The participants are:

Bob Bennes (BB), merchandising consultant with Caterpillar Financial Services Corporation in Peoria, IL.

Joe Carroll (JC), finance director with JCB Inc. in White March, MD.

Al Levenson (AL), vice president of United Rentals in Greenwich, CT.

Phillip Petrocelli (PP), executive vice president of NationsRent in Fort Lauderdale, FL.

Wally Savage (WS), marketing manager of Komatsu Financing in Vernon Hills, IL.

Sandrena Sorenson (SS), marketing director of Amerilease in Newport Beach, CA.

GX: When and why should a contractor consider an outright purchase of equipment?

WS: When you’re just starting up a business, buying equipment is one way to build equity. As the business matures and builds a sound financial platform with strong net worth, then you’re looking at such things as: Is the value of depreciation on my equipment worth more to me than, say, my ability to make payments and keep debt off my balance sheet?

BB: Among all the different acquisition options, there are balance-sheet and tax considerations that must be taken into account. For example, if you own a piece of equipment, you have the right to take depreciation benefits; if you lease it, you expense it. No one option has an advantage or a disadvantage when compared to another; they just have different implications for your balance sheet and tax situation. Some people want to buy equipment. They have pride of ownership, they’ll keep it a long time, and they’ll use it as an income-producing asset.

WS: One of the advantages of purchasing, from our perspective, is that we can really build a relationship with our customer throughout the lifetime of a piece of equipment. We can provide our customers with the lowest-cost source of financing available. When we enter into a financing arrangement, we’re entering into a long-term relationship with our customers.

BB: Also, don’t forget that the cheapest way to acquire equipment is with cash. Whether you pay cash or put a down payment on the equipment and then pay off an installment loan, there is a lower cost of ownership than with a lease. It’s just like a conventional financing instrument, such as a home mortgage. The smaller contractor likes that because he doesn’t have to deal with the complications of a lease agreement. He knows he’ll own the equipment outright at the end of a certain period of time. He wants to know what his balance is at the end of every month.

WS: Equipment has value when it is paid off. If you maintain your equipment well, the ability to sell it down the line could provide you with some profit opportunity. We have one customer who buys his machines and then sells them off every three years; that way, he avoids maintenance and repair costs while also making a tidy little profit from the sale of his machinery.

You also have the advantage of being able to write off the depreciation, but that’s not as important as the total costs of the equipment. If you have a real need for the equipment and your usage level justifies the purchase, you come out ahead.

AL: Generally speaking, depending on your level of use and the specific piece of equipment, you need to use a piece of equipment 60% to 70% of the time in order for the purchase cost to break even.

PP: Add to that the maintenance costs of about 15% to 18% per year of the original purchase price and it becomes an expensive proposition. The key statistic is utilization time. If contractors can’t keep the equipment working about 30 hours a week or more, then renting becomes the better option.

Should I Lease?

Each company has its own specific needs. If you’re just starting up, cash flow and debt lines might be tight. If you’ve been in business for a long time, you might want to keep you debt lines open and still use the latest equipment without committing to it. Leasing contracts can be drawn up to meet your specific business requirements.

When you lease equipment, you transfer the risks of ownership to the lessor, so you can concentrate on using the equipment as a productive factor in your own business. What’s more, you don’t have to deal with depreciation schedules and alternative minimum tax, you can just make the lease payment and deduct it as a business expense.

Your capital is not tied up in equity or costly down payments when you lease, and you can keep your lines of credit open.

Equipment needs are getting more and more specialized as well. What if you know what you need, but you don’t want to tie up your capital in an outright purchase or the down payment on an installment payment loan?

WS: That’s where renting and leasing come in: You try to get the right mix of equipment. Say a utility contractor gets a job that requires him to use a highly specialized excavator. He can do a two-year lease on that piece of equipment and not have to pay for a piece of equipment that he normally doesn’t need in his operation.

JC: Leases are typically most useful for longer terms, such as over 12 months (that’s why it’s called a long-term rental.) Leases are therefore ideal for long-term contracts where low equipment costs are necessary elements in bid equations or where extra equipment might be needed for a single job.

BB: One thing about leasing is that it allows you to avoid technological obsolescence. If you use a piece of equipment for three years and return it, then you know you’ll get the latest and greatest piece of equipment coming back out. What if I don’t want to purchase because of cash-flow considerations? I’ve put in a skinny bid, and I don’t know whether or not I’ll have enough work at the end of a project to keep the equipment. I can lease it and then buy it at the end of the lease, or I can return it and start all over again if I want to.

SS: Leasing is a flexible tool. You can trade up easily or add on additional equipment. It gives you access to the equipment you need without having to make a large down payment or impacting your lines of credit. In fact, leasing might actually cost less in after-tax dollars than an outright purchase would.

WS: I’d say that leasing a piece of equipment and buying it at the end of the lease isn’t always the most advantageous way of owning equipment because you’ve got that big balloon payment on the end. Probably one disadvantage to leasing is that you don’t build equity, and financing requirements are a little tougher. On a lease, you’re only really making payments in advance, and the decision is based on the customer’s ability to pay, not the value of the equipment. However, if your concern is cash flow, then it might work to your advantage because the monthly payment would be lower than financing. The big advantage of leasing is that it doesn’t show as much debt as purchasing, so it could be a plus for bonding.

Taking a Lease-Purchase Option

Eric Martinson, president of Gullcove Gardens in Beaufort, SC, got a JCB 212S backhoe tool carrier on a lease-purchase option from a JCB dealer, Southeastern Machinery. He needed the machine as a temporary solution for a large landscaping job: transplanting 2,500 camellias from Hilton Head Island to Lady’s Island. “I took the lease-purchase option because I needed it for about four months to help load trucks, but I’ve grown quite fond of it. Now I’m looking for a way to hold on to it.”

SS: If you pay cash, you’ll either have an interest cost if you borrow or, if you use your own funds, a possible loss of potential profit. When you add to this the fact that the real cost of future rental payments will be considerably reduced by the effects of inflation, it really isn’t that expensive at all. Besides, the lease plan can be specifically tailored to meet your needs. If you’re worried about obsolescence, you can use a Fair Market Value lease, which gives you the option to extend the term of the lease, return the equipment, or buy it at fair market value. If you’re pretty sure you want to buy the equipment at the end of the lease, you can use what we call “$1 Buyout.” If you’re worried about monthly payments, you can reduce them by using the 10% Security Deposit Plan. There are also skip-payment plans that allow up to three specified monthly payments to be omitted each year, which is particularly attractive to companies engaged in seasonal activities.

WS: Leasing options are very flexible today, but I stress that you really need to sit down and talk to your advisors; assess your own individual situation before making a purchase or leasing decision. You should probably be talking to a lot of people before you make your decision-your accountant, your tax advisor, your banker, and your bonding company. Everyone’s situation is different. You also need to be aware that if a deal seems too good to be true, it probably is.

BB: A few other considerations are that credit criteria might be stricter for leasing than for traditional financing, leases are subject to tax law changes, and there are maximum-usage hour limits per year with a lease.

Renting to the Rescue

Randy Roan is the owner of a construction company out of Conroe, TX, that does a lot of commerical-site prep work, mostly for large developers. His firm is usually booked about three months in advance. After that, Roan says, “When the economy slows and interest rates go up, work will decrease. But if you can’t make enough money from a job in order to rent equipment, you’re doing something wrong.”

His business is volatile enough that he can’t afford to buy the quantity of equipment he needs. While he owns bulldozers, backhoes, trackhoes, skidders, and loaders, he rents such items as trackhoes with thumbs, bulldozers with rakes, some maintainers, rollers, and compactors—about 50% of the equipment he needs.

Working with NationsRent, he has cut his maintenance and downtime expenses to a minimum. “Although I rarely have problems with their equipment,” Roan says, “if something does go wrong, I call and they come immediately to fix it for me.”

Roan (right) and Conroe, TX, store manager Rich Kopple check preparations for a commercial building project

More and more contractors are looking to rental as a way to fulfill their equipment needs. What are the factors contributing to this shift from ownership to rental?

AL: It used to be that years ago you bought your own equipment because you wanted your own steel and you wanted to see it. However, the world is moving toward corporate outsourcing. If you look at the average contractor’s fleet in 1993, about 5% of its equipment was rented and 95% was owned. In 1998, those numbers shifted to 20% rented and 80% owned—a fourfold increase in rental equipment.

PP: The technology in this industry is changing so fast now; there are literally dozens of attachments that you can get today that you couldn’t get a few years ago. When I was a kid, there were two bucket sizes for a backhoe; now there are 25. Skid-steer loaders have all kinds of attachments. As a small contractor, you can’t afford to own all of them, but you can’t afford not to have them available either.

The main benefit of ownership is that the contractor has equipment at his disposal at any given time. That’s why we see our competitive advantage as the process of making renting easier than owning through solid customer relationship and virtually immediate access to equipment.

Why Rent ?

Right Equipment for the Job. Taking the “we’ll make it work” approach just isn’t good enough today. Using the right piece of equipment for the job can save you time, money, and eventual liability for things that go wrong.

Decreased Downtime. Equipment isn’t really of any use to you unless you are putting it to use. Renting the equipment you need when you need it makes sense.

Reliable Maintenance and Repair. When you rent equipment, full maintenance is part of the contract. That means you don’t have to run a repair and parts shop in addition to your own business. Moreover, if equipment should break down, the rental company will immediately repair or replace that equipment.

No Storage Crunch. No matter where you business is located, it’s unlikely that real estate is cheap these days. Rental companies can take that headache away from you.

Making Obsolescence Obsolete. By renting equipment, you not only have more choices, you also get the very latest equipment. Rental fleets upgrade regularly.

Sharper Cost Control. Acquisition, repair, maintenance, transportation, and facility expenses are some of the many variables that must be taken into account when calculating the real costs of ownership. When you rent, the only accountable cost figure you have to keep track of is the one on the invoice.

Better Inventory Control. There is less pilferage when it comes to rented equipment. This is because equipment that must be returned is often watched more closely than equipment that is owned.

Tax Benefits. The user of rental equipment pays no personal or business property taxes or license costs.

Optimizing Your Capital. By renting, you free-up your capital for other uses that might be more profitable to your business. In addition, you might find that your borrowing and bonding capacity is greater because rental equipment does not appear as a liability on your balance sheet.

JC: Rentals are often called on for very short-term projects, such as a day, a week, or even as long as a month or two. They may be used for specialized equipment not normally used by the contractor. Rental equipment can also fill in for short-term replacement when owned equipment is out of service.

AL: When you rent, you’ll always have the choice of the best equipment for the job. When you own a piece of equipment, you tend to use what you own. There are always new things coming on the market today, and that leads to productivity improvement.

PP: Until recently, the infrastructure in the renting industry was not in place. Typically, contractors rented from mom-and-pop operations, and the equipment tended to be older and more tired. The larger rental companies have the advantage of volume buying, so our equipment is newer and tougher than it used to be. The average age of our fleet is 25 months. We’ve done a lot of research to find out what our customers want from us. It comes down to availability, breadth, depth, and selection; it’s providing what they want when they want it.

AL: Availability and capability to deliver are critical, as is service. It’s important that the equipment get there on time, that it works, and that if it should break down, they can get it fixed or replaced very quickly. Rental equipment is more reliable from the get-go, so it tends to break down less often. In addition, we put our equipment through a very rigorous maintenance program when it goes out and when it comes back in.

PP: Equipment today is different than it was 20 years ago. I used to be able to fix my own motorcycle, but I couldn’t fix a motorcycle today because it’s all computer chips. You need specialized mechanics to maintain your fleet, and rental companies can provide that. And with today’s real estate prices and tougher zoning laws, the contractor often doesn’t have the storage space for all of his equipment needs.

AL: I break down the advantages of renting into four basics-costs, operations, finance, and safety. When you take into account things like downtime, service, costs, storage, insurance, and disposal, for a whole slew of reasons, rental is often less expensive than buying.

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From the operational perspective, you’ll get a modern piece of equipment, your users will be happier and more productive, and if there is a breakdown, it will be fixed by qualified technicians. From a financial perspective, it’s very clear that you don’t have to use your credit line or tie up your capital. And the last reason is safety. With a reputable rental firm, you know that the equipment is maintained to specifications, that we’ll make sure it meets all the ANSI and OSHA requirements, which will reduce your liability.

PP: In addition, the financial benefits include higher profits, tax benefits, and the ability to take on larger, more profitable jobs because contractors who rent don’t have to buy, maintain, and haul equipment from job site to job site.

JC: Renting, leasing, and buying through financing are simply tools of the trade. A good business manager should know his tools and use them where they best fit his needs.