When expanding a business, one of the most difficult decisions may well be the most overlooked: How are you going to pay for the equipment when you need to get bigger? And how do you decide whether to purchase or lease?
“There are numerous options,” says Stephen King, president of craft bourbon maker Ironclad Distillery Co. in Newport News, Va., who was faced with those very choices when his company moved to commercial production several years ago. “How do you know what’s going to be the best option for your company?”
Or, in the words of one winery executive contacted for this story, “We’ve made so many mistakes in terms of purchasing versus leasing that we need some help ourselves.”
There’s not necessarily a one-size-fits-all answer. It depends on what piece of equipment you need and how quickly you need it. What works for a winery that wants to solve its forklift quandary may not apply to a brewery that wants to move from a five- to 30-barrel fermenter.
“Everyone’s needs—and how they approach them—are different,” says L.J. Govoni, founder and CEO of Boston Capital Leasing in Clearwater, Fla., which facilitates equipment financing for small breweries and distillers nationwide. “Wineries, by the nature of what they do and how much they have to spend to do it, have to look at their decisions differently than other startups and small producers.”
Says King, “Flexibility is the key. You want to give yourself the best way to upgrade to the newest, larger capacity equipment, and you need the most flexibility to do so.”
It starts with knowing what questions to ask to make a profitable decision.
Do you need new equipment?
In some ways, this is the most difficult question to answer, says Govoni. Sure, if something breaks, that’s one thing. “But if you don’t plan on expansion when you start the business, you’re not planning for success,” he says. “Does your business plan include expansion? Because it must be part of the process from the beginning.”
In other words, start with the understanding that the equipment you have won’t be enough when you get to a certain point in the business’ growth, and know when to start looking for an upgrade, says Bill Eue of Bierstadt Lagerhaus in Denver, Colo., a craft brewery and restaurant. “Make sure your demand matches your supply,” he says. “It can seem puzzling when people do it any other way. The last thing you want to do is to roll the dice and take a gamble.”
New or used?
Few answers have changed more over the past decade, due in large part to the unprecedented growth in small wineries, breweries, and distilleries. Traditionally, used equipment was significantly cheaper, and startups and small producers chose that option to save money. But no more.
“The discount is almost gone for used equipment,” says Rick Wehner, Denver-based director of Brewery Finance, which finances equipment for small breweries and distilleries. “There’s so much demand for it, thanks to the craft boom, that one of the only reasons to buy used anymore is delivery time.
“It may take six months to get new equipment from a manufacturer, but you can get the used from the guy down the street in a couple of days or a couple of weeks. If you need the equipment right away, then get used. Just understand that you’re not going to save much.”
Buying versus leasing
The answer here, too, has changed over the years, as a number of different forms of leasing have evolved. Leasing is no longer as simple as paying a monthly fee and then returning equipment at term’s end. Rather, there are leases where you can buy the equipment at the end of the term; more traditionally lease it and return it; lease to purchase (like rent-to-own); or even use the leased equipment as payment at the end of the term to enter a new lease for new equipment.
“Bank financing is more transparent,” says Dan Aguilar, senior vice president and North Bay region commercial banking manager for Mechanics Bank in California, “and you know what your cost of capital is. With leases, given upfront payment, monthly lease payment, and the residual payment at end of the lease, it’s harder to know what your cost of capital is. Sometimes, leasing can be more expensive than a bank loan.”
Wehner cautions that comparing bank and leasing rates is difficult, because they aren’t exactly the same thing. The best comparison, he says, is the difference between buying and renting a house, where renting is often less expensive and requires less paperwork and less credit, but buying can result in equity and tax credits. “A lease isn’t an amortized loan and therefore an APR isn’t part of the analysis,” he says, “much in the same way that renting a house involves a monthly payment, but not an interest rate.”
On the other hand, even though lease rates are higher and there additional cash outlays required (first and last month payments, for instance), a leasing company will lend close to 100 percent of the cost of the equipment. Banks typically finance 80 percent for new equipment and 70 percent for used, says Charles Day, California North Coast regional manager for Rabobank. What’s more, “leasing companies leasing companies usually put a greater emphasis on collateral value, so leases are sometimes easier to obtain than equipment loans from banks,” he says.Also worth considering: maintenance and repairs, which may be covered by some leasing contracts but are the full responsibility of a buyer. Clem Villars, cellar master for Pedernales Cellars in the Texas Hill Country, says his winery owns its forklifts, but maintenance is one reason he’d consider leasing the forklifts when it’s time to replace the current ones. A service call can be hundreds of dollars per visit but would be covered as part of the lease.
Making the decision
Talk to lenders and producers, and consider:
- Cash flow. Can you afford the higher payments to buy? Or is it more comfortable for you to lease, with its smaller monthly payments? This is even more true if you want to buy using cash, which leaves even less room for error.
- How long will you need the equipment? When King started producing commercially, he leased a 26-gallon boiler with a pot and column still. It didn’t make sense to buy the boiler, since his business plan called for upgrading to a bigger boiler when the business grew.
- Do you only need the equipment at certain times of the year? Villars says another leasing option for a winery may be presses, which sit idle for as long as nine months per year. It might be more cost efficient to lease them only after harvest, when there are grapes to be pressed.
- How durable is the equipment? Do you want to buy something with a short shelf life or that breaks often (such as some filtration equipment)? Steel tanks, on the other hand, will last almost indefinitely, and are better candidates for purchase.
- Logistics. If you opt to return equipment when your lease ends, how will you get it out of your facility and back to the lender? How do you move a steel tank?
What does your accountant say?
Finally, don’t do anything until you talk to your accountant. The differences between leasing and buying include a number of complicated tax and insurance issues, including depreciation and how you can expense the equipment. Several lenders said this is one of the most important pieces of advice for would-be borrowers, because federal and state tax laws can be contradictory and confusing.