Author: Tronserve admin
Monday 26th July 2021 09:24 PM
Common Industrial Equipment Financing Traps to Avoid
When financing industrial or manufacturing equipment, there will be a few pitfalls to avoid. Some of the “gotchas” in equipment financing and leasing contracts are outright frauds, while others are more subtle. Understanding the possible financing risks can help keep from a costly and unpleasant experience when acquiring equipment.
One pitfall to be aware of is “interim” or “pro-rata” rent on prefunding. Pro-rata rent denotes payments that are made up front of a lease or finance commencement date. Pro-rate is the same as rent on an apartment which is due on the first of the month. If a renter moved in on the 15th of the month they would be charged for half a month of rent.
Think of an order for $2 million worth of production line equipment. Sellers usually will likely not start work up until receiving the first progress payment (often 25-50 percent of total cost). Also imagine it may take 15 months between the first progress payment and delivery, installation and inspection of a completed production line. And finally, assume having been approved for an 84-month term with payments of $28,000 per month.
When a lender makes a payment well before delivery, the industry jargon word used is “pre-funding.” Many equipment leases stipulate that pro-rata payments must be made for the time period between pre-funding and delivery, installation and inspection of the completed order. In the above case in point, interim may consist of 15 months. During that time, 15 payments of $28,000 may be charged, and those payments do not reduce the principal balance of the equipment lease or finance contract. In the above example, pro-rata could represent $420,000 in unplanned finance charges. As a result, equipment lease companies will joyfully offer to pre-fund progress payments to an equipment merchant, as those pro-rata payments represent pretty much pure profit.
Large interim payments are a frequent incident in “non-bank” equipment financing. Knowing the dangers of interim payments ahead of time creates a company options to minimize or negotiate unnecessary finance charges. As an example, one can negotiate upfront that interim is to be paid only on the advance amount (i.e. on a 25 percent progress payment towards a $2 million equipment purchase, pro-rata is likely to be negotiated to be paid on the $500,000 advance, versus the entire $2 million). On the other hand, short-term credit lines may be a solution to fund progress payments. In some cases, qualified buyers can negotiate with equipment lenders to have pro-rata payments removed or significantly reduced.
One more lure to be mindful of involves equipment financing or equipment leases with a quarterly payment. These transactions also can carry “pro-rata” language within contracts which is commonly mistreated by unscrupulous lenders. Some lenders create lease commencement dates every business day of the year; this makes them to collect 89 days of interim rental payments aside from the delivery date of the equipment. For example, going back to the case in point above with $2 million worth of equipment, slipping an extra 89 days of “rent” into a contract allows the leasing company to get an additional $83,066 in payments without creating any actual value whatsoever.
Evergreen lease clauses can also become an issue for many businesses. Many equipment lease contracts are “lease to own,” meaning ownership occurs right away with the last payment. Other lease contracts are written as a “lease with an option to own.” This means that after making the final payment, the company may purchase the equipment or return it. But, covered up deep within some contracts is language stipulating that intent to purchase must be made between 90 and 180 days prior to the end of the lease; failure to provide such notice can trigger an automatic 12-month extension of that lease. Back to our $2 million production line, that extension could possibly represent an additional $336,000 in payments. Equipment lease companies usually do not notify customers of upcoming lease expirations. There have been reports of companies that have made several years of other sorts of payments because they were unaware that leases had “rolled over.”
All the above financing and leasing traps can frequently be stopped by carefully reading any equipment financing or leasing contract. It is wise to have an attorney review contracts prior to signing; this is specifically true for purchases of equipment that exceed $150,000 in costs. A further recommendation is to have an attorney that specializes in equipment leasing review contracts as they should be customary with most of the common problems that companies run into when financing equipment. These simple steps can possibly save a company thousands when financing equipment.
This article is originally posted on manufacturing.net