The general topic of this post is finance, and the two lessons regarding asset purchase agreements and leasing come from the entrepreneurial finance class I'm taking this quarter.
The material can at times appear dry, but I've enjoyed digging deep into the actual details and semantics behind real world business deals and operations, and this week I've learned a bit about how small businesses are purchased in the real world and some additional reasons behind why companies lease equipment that I would not have considered otherwise.
Asset Purchase Agreements: Small Business M&A
We had the pleasure of hearing a guest speaker in our class who came from the car dealership industry. He had purchased and developed several profitable dealerships around California and was giving us a lot of the inside "scoop" on how the deals really got done.
The first and most major new point that I took away was that small business balance sheets are mostly all "fiction" and not to be trusted. When buying a small business, the purchaser should really just buy the assets through an asset purchase agreement and not the actual company entity (stock). This will allow the purchaser to focus on the tangible, (more) easily appraisable values of the assets and not worry about the liabilities or any hidden cans of worms that can spring open from the purchased business in years to come. I never knew asset purchases were a possibility; I thought it was all just whole company purchases, so that was neat to learn.
I always thought that companies leased equipment when they don't need to use it for too long, are strapped for cash, or when the equipment can quickly become obsolete. I learned through a case analysis of a lease versus buy decision that there are many additional conditions when companies would prefer to lease as opposed to buy assets:
- High variability in net income and likelihood of losses (and thus cannot take full advantage of the tax shield of debt payments that finance an asset purchase)
- Uncertain tax rates (since purchasing an asset is often done through debt financing which derives much of its value from the tax deductibility of interest payments)
- The lessor (the party leasing you the equipment) has a higher tax rate than you and will pass the tax advantage on to you (because they can use the tax shield better than you)
- Less restrictive covenants than debt (debt financing for equipment purchase may put many restrictive financial covenants or requirements on a company, which may not occur in the leasing scenario)
- Ability to transfer maintenance to lessor (so lessee not responsible for on-going maintenance and repairs, which is especially useful for high-tech or complex equipment)
- Lessor has lower cost of capital and can transfer their capital cost to you (this will make it cheaper to lease through the lessor since it is effectively cheaper for them to buy the asset than for you to buy it)
- Lessor has better knowledge of the equipment market and can sell off the asset better at the end of its useful life (similarly making the asset purchase cheaper for the lessor than the lessee)
- Another capital source may ignore lease payments when considering your debt or fixed income obligation position, which will provide more flexible financing in the future