July/August 1998
Sure you can buy that new baler—or crane, or shear, or shredder—with cash, but there are a host of other options to help you purchase the equipment you need.
By Cathleen O’Connor Schoultz
Cathleen O’Connor Schoultz is a writer based in Arlington, Va.
For most people, a house is the most expensive item they ever buy. But for scrap processors, buying a standard piece of equipment such as a baler or shear can cost as much as a house—or a mansion, if they want a supershredder. And processors might have to make several of these purchases during their career, as equipment wears out or they decide to expand their business.
So, how do recyclers pay for big-ticket equipment that can start with a price tag of several hundred thousand dollars and easily shoot up to more than
$1 million?
The answer varies, of course, based on factors ranging from the liquidity of the customer to the cost of the machine, as well as what kind of financing assistance the manufacturer offers. Though the long-standing tradition in the scrap industry is to pay cash for equipment, today’s savvy processors know that they must at least be aware of the other options to avoid making a costly mistake.
Cash Is King
The scrap industry has long been a cash business in terms of paying cash for scrap from suppliers as well as buying new equipment to process that scrap. Sierra International Machinery Inc. (Bakersfield, Calif.) understands this well. The company makes large shears and shear/balers that sell for $200,000 to $1 million. Yet, about half of its customers pay cash, says John Sacco, president. The other half arrange credit on their own.
It’s pretty much the same for Mike Murphy, product manager for hydraulic excavators at Komatsu America International Co. (Vernon Hills, Ill.), where scrap processors usually buy equipment that costs anywhere from $500,000 to $1 million. “The conventional wisdom is that scrap dealers usually pay cash,” Murphy says.
Shedding some light on that conventional wisdom is scrap executive Jeff Cole, chairman and CEO of Ferrous Processing & Trading Co. (Detroit), who explains: “If you have the money, paying cash is good for your balance sheet and helps to collateralize debt.”
It also makes it easier to get some equipment-related work done. Ferrous Processing & Trading, for instance, spends “a great deal of money on site and environmental improvement,” Cole says, noting that the company has paid as much as
$10 million for structures to house its shredders, as well as sound barriers, oil separators, and other aspects of site preparation and installation. Although expensive and essential, these improvements can be difficult to finance because banks might not understand their usefulness. Paying cash eliminates that headache.
Of course, the cash isn’t necessarily paid in one lump sum. Progressive payments are typical for scrap processors. These involve, say, a 10-percent down payment followed by three monthly payments of 25 percent during construction, with the remainder paid when the equipment is ready to ship.
The downside to paying cash is obvious—you have fewer dollars on hand for other needs, such as a financial cushion in the event of an emergency. And even though many scrap processors will always believe cash is best, there are alternatives.
Looking For Mr. Good Loan (or Lease)
Perhaps the single most common alternative is to obtain financing directly from the equipment manufacturer, in roughly the same way you’d get a car loan from the company that made your automobile. Equipment makers such as Komatsu, Caterpillar Inc. (Peoria, Ill.), and others see such in-house financing as a large and growing part of their business. Some have even added “captive” finance subsidiaries that exist to help customers buy their big-ticket products.
Komatsu, for instance, acquired KDC Financial L.P., located in nearby Downers Grove, Ill., in 1988. The subsidiary helps buyers finance equipment purchased from Komatsu distributors, and their loan officers understand the scrap industry far better than the average banker.
Caterpillar, which sells material handlers, wheel loaders, integrated tool carriers, and more to the scrap industry worldwide, also provides a range of financing alternatives through its subsidiary Caterpillar Financial Services Corp., headquartered in Nashville.
With manufacturer financing, scrap processors have two basic choices:
- arrange a loan through the manufacturer’s captive finance company to buy the equipment outright; or
- set up a lease agreement that may or may not require the purchase of the machine at the end of the lease term.
With a loan, the tax advantages of ownership apply—that is, depreciation—and at the end of the payment schedule—say, 48 months—the customer owns the machine. This is a popular means of buying equipment. The majority of Komatsu customers financing their purchases through KDC Financial choose a loan rather than a lease, notes Wally Savage, marketing manager. However, leasing has increased as a percentage of overall business for Komatsu in each of the past five years.
Likewise, leasing has never been all that popular with buyers of the Lindemann line of balers, shears, and other recycling equipment, notes Tim Gore, sales coordinator for the Pineville, N.C.-based operation. But Gore expects leases to pick up now that Lindemann is part of a larger corporation, Sweden’s Svedala Industries, which offers its own in-house financing.
After all, explains the marketing manager of another such in-house service, leases have attractive features, such as generally allowing the customer to pay less cash up front—often just the first payment in advance and a small deposit—and they often require a lower monthly payment than loans.
Leases are generally available in two broad categories:
- operating leases, in which you can—but aren’t required to—purchase the machine after the leasing period ends; and
- capital or finance leases, in which you’re expected or even required to purchase the machine at the end of a set time period.
Each has its own financial benefits. An operating lease, for instance, allows you to expense the payments, while a capital lease is a tax shelter and can be depreciated.
Leases can also be subdivided further. KDC Financial, for instance, offers two types of operating leases. With its Fair Market Value lease, the lessee has the option of buying the equipment at the end of the lease term for its current value determined by an independent appraisal.
With its Advantage lease, the lessee can decide at the close of the term whether to purchase the equipment at a predetermined price, return it to Komatsu, or renew the lease at predetermined payments. Customers who renew have the same choices at the end of that extended period, with the purchase price also predetermined at the original signing.
Finding Flexibility
Whether obtaining a loan or a lease from the manufacturer, scrap processors should look for flexibility. Manufacturers contacted for this article generally agree that there are few hard-and-fast rules in financing big-ticket equipment—what it takes is a lot of give-and-take. As one manufacturer explains it: “The equipment is so expensive that everything ends up being negotiated.”
For instance, down payments at equipment maker Wendt Corp. (Tonawanda, N.Y.) can vary from zero to perhaps 25 percent of the equipment’s cost, depending on what type of machine is being purchased and how it’s being financed, notes Tom Wendt Jr., sales and product manager. Negotiations often cover the overall price as well as the warranty, with items like extended warranties and free spare parts sometimes being used to sweeten the deal for long-standing customers, Wendt says.
KDC Financial generally looks for a “modest” down payment of 5 to 25 percent, depending on the buyer’s credit history, explains Murphy. But leases for 100 percent of the equipment’s cost aren’t uncommon, he adds.
And Savage notes that although the technology is highly specialized, KDC Financial uses the standard criteria for approving credit applications: good financing or leasing references, comparable credit, and a sound financial statement.
At Cat Financial, “we treat each customer and situation as unique,” says Rob Coon, marketing manager. “Cyclical businesses have special needs and changing positions.” Caterpillar offers flexible terms tailored to its scrap customers, such as installment sale contracts that enable customers to make a down payment or trade-in, acquire equipment, and then structure payments over time, Coon notes. The company also offers various payment schedules such as monthly, quarterly, or semiannually.
Payment Plans
Lease payment plans can include more than just the cost of the equipment. Some companies offer programs that incorporate regular scheduled maintenance, training, and other special services into a monthly payment schedule.
While these maintenance plans do require higher monthly payments than the lease by itself, they’re designed to cost less than if the customer tried to perform all the maintenance itself. The regularity of inspection under such plans should prevent major breakdowns that would disrupt production and perhaps require the customer to rent equipment while also paying to fix the broken unit.
Various manufacturers offer seasonal, skip or step payments, accelerated (or step) payment plans, and a new type of balloon payment. While the traditional balloon was a large sum of money due at the end of the lease, today’s balloon may or may not be so inflated. It’s still the last lease payment, but it can run anywhere from a single dollar to more than 50 percent of the acquisition price, depending on circumstances.
With skip and seasonal leases, payments are eliminated or substantially reduced when you’re not using the equipment. Hence, you skip a payment during the slow times or make payments only when your business is in season.
There are also deferred payment plans for buyers who won’t generate significant revenue until two or three months down the road. And with the accelerated or step payment plan, a customer opts to make high payments for the first two or three years of the machine’s life, while the unit is operating at its peak. The principal is quickly reduced in this manner, leading to much smaller payments in the equipment’s later years, when it generates less revenue and costs more to maintain.
A Little Help, Please
Whether or not they offer in-house financing, manufacturers also can help customers work with commercial banks.
“We recommend that buyers go to their local banks, where they already have a relationship,” says Dean Carpenter, CFO of Sierra International Machinery. But if a bank’s loan officers are unfamiliar with the scrap industry, companies like Sierra can help them better understand the value of the equipment being purchased. For instance, Carpenter has talked with banks about how equipment being financed will be used, how long it will last, and what its potential is for generating income.
Wendt adds that banks also like to know the maintenance costs on machinery and the unit’s resale value after set periods of use, say two years or five years, especially for loans above $200,000.
At Harris Press & Shear (Peachtree City, Ga.), credit manager Jesse Wallace says he sometimes must explain to bankers why the total cost of equipment, especially for foreign buyers, might include a spare parts package to cover one or two years of operation. Since these costs add only to the price tag and not the collateral, they can be confusing for commercial lenders.
Even Cat Financial, with its extensive system for in-house financing, will help customers get loans from outside sources. Two years ago, Cat Financial created a system to electronically connect information about transactions that require funding with interested commercial lenders. To date, the system has helped finance more than $3 billion of business.
Meeting Special Needs
Cash, loans, and leases aren’t the only ways for scrap processors to obtain equipment, of course. New options are created all the time, and some long-standing options exist just to meet the special needs of particular buyers.
For instance, overseas customers can feel more vulnerable than domestic buyers should a mishap occur before their equipment is delivered. They’re naturally reluctant to pay a large percentage of the purchase price up front, notes Tony Morgan, president of shredder manufacturer Newell Industries Inc. (San Antonio), especially if they don’t want to risk dealing with the U.S. legal system should a disagreement arise. Morgan solves this problem by accepting an irrevocable letter of credit, whereby the foreign buyer releases funds to its bank. The money is then paid to the manufacturer when it delivers certain documentation such as shipping papers and bills of lading.
Renting equipment is another option, albeit a rare one given the amount of wear and tear scrap equipment sustains. Wendt is currently experimenting with a rental option that would require a 10-to-20-percent down payment, plus monthly fees for a minimum of three months. The company reports many customers are interested in the idea.
There’s also a market for used scrap processing and handling equipment. Again, certain realities of the scrap industry—such as rapid changes in technology and the customization that processors often require—steer many customers away from this option. Sierra International Machinery, however, lets customers post ads for their used Sierra/Idromec equipment on its Web site, and Sierra then puts its sales force on the job selling the used equipment, sometimes in foreign markets like Mexico and South America.
Finally, some scrap companies have learned that one way to obtain new equipment is by selling something—namely, their businesses. Being acquired by a large corporation with deep pockets and a lot of subsidiaries can open up various resources to the acquired company, either by making funds available to buy new equipment or by trading machinery between subsidiary sites. But most firms would probably consider this only a side benefit to a good consolidation arrangement; it’s unlikely to become a widespread means of adding that extra baler, shear, or crane.
So it’s settled. You’ve found the machine of your dreams. Your shopping is complete and, metaphorically at least, you step up to the register. The sales clerk glances in your basket and begins the litany: “Will that be cash or loan? Operating or capital lease? Down payment or ... ” •
Sure you can buy that new baler—or crane, or shear, or shredder—with cash, but there are a host of other options to help you purchase the equipment you need.