Every business usually needs external finance as well as its own capital, in order to fund its activities. As well as fluctuating overdraft and medium or long-term loans from, e.g. a bank, a business might need to examine other ways of financing the acquisition of its moveable assets (i.e. other than land and buildings, which are usually funded by long term mortgage).
Incidentally, in relation to bank finance, small and medium sized enterprises should be aware of the new measures to be put in place by the major clearing banks to answer the concerns of the Competition Commission about banking practice towards SME's. The days of having no interest on credit balances in current account, and having to "bundle" operating and loan accounts with the same lender look set to end. Contact Bruce Burniston for more information on the implications of the report of the Competition Commission issued in March 2002.
In addition to medium term bank loans to finance the purchase of plant and machinery, a business might want to examine the alternatives of leasing or hire. There are no real restrictions over what kind of assets might be the subject of leasing, but most leasing arrangements cover such things as commercial vehicles, cars, computers, vending machines and office equipment. Brief differences in agreements are: -
An Operating Lease.This involves the use of the asset for a period shorter than its expected life, in return for payment of rental. Generally the rental is not linked to recouping the asset's purchase cost and may be cancellable by the lessee on giving short notice without penalty. Rental charges would be an operating expense charged against profits for tax. The lessor usually remains responsible for the asset, though may charge for regular maintenance.
A Finance Lease, on the other hand, does not usually involve the lessor in selecting or supplying the goods. The business will chose an item of equipment from a supplier, and the supplier sells that item the leasing company which then leases it to the business. The duration of the lease usually relates to the major part of the expected asset life and the lessor normally will have no responsibility for maintenance, insurance or repairs. It is just financing the purchase and will thus seek to avoid all responsibility for whether it works satisfactorily or not. Though finance leases are standard documents, businesses need to take great care to ensure that they can get redress from someone if something goes wrong with it. Because the business has not purchased it directly from the supplier (who sold it in fact to the leasing company) there is no breach of contract claim available for faulty goods or workmanship. Also finance leases cannot usually be terminated early and carry heavy penalties if they are. Sometimes they allow for the asset to become owned by the business at the end of the term, usually through payment of a nominal sum.
The tax treatment of finance leases is more complicated, than for an operating lease.
We have considerable experience of advising on the terms and conditions of all types of asset finance agreements and also with problems that sometimes arise after they have been entered into. We can also advise in relation to other banking or factoring arrangements and upon personal guarantees which lenders will often try to obtain to back up their security. Proposed changes to insolvency law (as at March 2002) may significantly increase the potential liability under personal guarantees and therefore directors need to take great care when asked to enter into such arrangements.
Chris Davies on 01792 529636 c.davies@johncollins.co.uk
Steve Penny on 01792 529634 s.penny@johncollins.co.uk
