The financing of equipment in the United States exceeds one trillion U.S. dollars annually. Such strong market activity undoubtedly means that product vendors can increase product sales and competitive advantage simply by making customer equipment and other product financing readily available. Proposing the sale of equipment, without offering on-the-spot customer lease or other suitable financing options that many customers need, opens the door for competitors with fast and easy “in-house” financing to walk in and win the business. Simply referring a customer to a third-party leasing company or bank for product financing, or leaving the customer on its own to work out a financing arrangement, can create issues and friction that rob a product vendor of a sale and possibly recurring revenue opportunities.
In-House Financing Can Sell Your Products
The majority of all equipment users look for favorable, cost-effective ways to finance their equipment acquisitions, often preferring leasing provided by product vendors and referred to as “in-house” financing. Users believe that such arrangements will offer better terms than those available from banks or independent financing companies. Generally, they are correct. So, clearly, product vendors with readily available in-house leasing or product financing will fare better and enjoy a distinct marketing advantage over competitors who do not. In addition, under new tax legislation recently enacted (the Inflation Reduction Act), there are now very favorable tax incentives for green energy equipment, such as a 30% investment tax credit for hydrogen fuel cell systems, that can substantially reduce customer equipment leasing rates, which, in turn, can incentivize customer equipment acquisitions.
Setting Up an In-House Financing Operation
Establishing an in-house financing operation can not only increase product sales, but can also add a valuable new profit center. In the past, an in-house operation set-up proved difficult and costly because of highly specialized components typically required, such as credit assessment, documentation, deal processing and operational management. Consequently, equipment sellers were generally well advised to rely on third-party financing sources. Notwithstanding the operational and expertise challenges and added cost of setting up and running a financing activity, however, a few product vendors, including Cisco Systems, Inc., benefited greatly in increased product sales and profits from establishing their own “in-house” product financing facility.
In today’s market, the availability of cost-effective third-party service providers that offer virtually all the technology products and services needed to establish and operate a financing activity has substantially reduced associated set up and operational costs and challenges. Thanks to these relatively recent innovative product and service offerings, which include specialized financing-related software, and easy to access third-party operational service providers, product vendors can now easily set up an efficient, user-friendly and cost-effective product financing operation for increased product sales and profit. For example, qualified back-office service providers, such as Great America Financial Services (www.greatamerica.com), can handle the billing and collection of financing payments and assess applicable state and local taxes due and payable. So, easy access to software, technology and third-party services minimizes the expertise a product vendor needs to set up an effective product financing process as a part of its product marketing strategy.
The Pros and Cons of Establishing a Product Financing Operation
Customer financing capabilities offer product vendors a number of obvious, as well as less obvious, advantages. Offering prospective customers excellent products, along with a quick and simple way to finance the product’s acquisition, has historically been shown to increase product sales, while the financing interest component can add to a product vender’s profits. This is particularly true, as suggested above, for product vendors selling certain green energy equipment where there is available attractive tax benefits, such as a 30% investment tax credit for certain green energy systems placed in service in 2022. Such tax benefits, when properly included into the lease pricing, can significantly reduce the customer product financing cost, and, thereby, significantly improve a customer’s incentive to acquire the equipment, while allowing the product vendor to comfortably participate in the financing rate profits.
The existence of a secondary (used equipment) market for products financed is something often overlooked by a product vendor. A bank or independent leasing company typically makes its money primarily from its interest rate spread over its cost of money and operations and, then, looks to add substantial profits from end-of-lease product re-leasing or sales, referred to as residual profits. As most leasing companies have relatively small equipment remarketing departments, they typically dump end-of-lease equipment quickly into the market, often through equipment brokers. This type of used aftermarket equipment fire sale can dramatically and adversely affect a vendor’s new product sales, particularly for products with a long useful life. By controlling the aftermarket sales through their own in-house financing operation, or, at a minimum, a remarketing arrangement with third-party financing companies providing customer financing, a product vendor can not only protect its new product sales, but it can generate additional profits from secondary market activity.
It is a well-known sales fact that once a company has developed a customer relationship, such as through a long-term and ongoing equipment financing relationship, the customer rapport established can ease discussions and facilitate repeat business, including the sales of additional products, services and supplies. For example, many customers take time initially to thoroughly review and negotiate a lease contract, but when the document has been agreed to customers are often comfortable using the same document for new transactions with little further review, minimizing legal and other document review time and costs. Having a lease or other financing document in place with a product customer can provide an advantage over a competitor introducing new financing documentation that needs time-consuming legal review and negotiation.
While there are many advantages to an in-house product financing operation, there are some distinct challenges, which, with the right strategy, are manageable. Clearly, providing in-house financing for a customer with its own funds potentially exposes the product vendor to customer credit risk. Making a credit assessment takes a particular expertise, but today, readily available software from companies, such as PayNet (https://paynet.com), can dramatically reduce the credit assessment risks, drawing on a wealth of customer historical data and existing and historical market trends, to benchmark, online, where there may be an undue credit risk. Hiring an experienced credit manager, however, is often an essential part of any financing activity to reduce and manage customer credit risks, unless a third-party customer financing arrangement is used where the arrangement is structured so the credit risk is passed on to a product vendor’s third-party bank or a leasing company working with the product vendor. There are also specialized financing documentation and operational needs that must be addressed, much of which, as suggested earlier, can be accomplished via third-party service providers.
Deciding on How to Approach Establishing an In-House Financing Operation
There are three basic ways to set up an in-house equipment financing activity, which, in each case, start by establishing a vendor financing subsidiary affiliate. The first way is to replicate, in the specially formed subsidiary, an actual leasing operation, including all management and administrative personal and operational processes, funding both the day-to-day operations and customer financings with internal and/or third-party bank funds. This is the most complex, expensive and time-consuming approach, but will likely produce the most profits. The second way is basically the same as the first, but merely arranging with third-party service providers to handle all administrative aspects, such as billing and collecting on customer leases. This approach is more cost-effective than the approach first discussed, requiring less personal and operational aspects. The third approach, the most cost effective and easiest to set up, but with likely reduced internal financing profits, is to enter into a “private label program arrangement” to handle all customer financing, with, preferably, at least three independent banks or leasing companies, referred to as “third-party financing companies”, contractually involved so that as a group they can provide financings for transactions of varying deal sizes and credit situations. The private label aspect means that the customer will believe that the vendor’s financing affiliate is actually providing the financing, because under a properly negotiated private label program arrangement the vendor’s third-part financing companies will interface with the customers on all aspects of the financing process in the vendor’s financing affiliate’s name. A word of caution: If any leasing company you are working with states it is pricing lease rates taking into account any tax incentives, that claim should be independently verified to ensure that your customer pricing is in fact the lowest possible. A few have a tendency to state something that is in fact not true.
Setting up an in-house leasing activity with a state-of-the art customer financing strategy that combines essential in-house processes with reliable third-party technology, software and services providers, or simply using a well-negotiated private label program financing approach, will allow any product vendor to successfully and cost-effectively leverage its product sales efforts, thereby increasing its profits by ensuring a competitive advantage, and, accordingly, make it easier to win and retain new business sales and hedge against changing market conditions.