Practical Winery
58-D Paul Drive, San Rafael, CA 94903-2054
phone:415/479-5819 · fax:415/492-9325
Business - Page 1

March /April 1999

Equipment/Barrel Leasing:
A powerful tool for your financial toolbox

by Carol Caldwell-Ewart

Suppose that, just at the moment when you need expensive equipment for the vineyard or winery, someone buys the exact brand and model you need and agrees to let you use it for the next few years. All you have to do to use the equipment is pay a monthly fee — no down payment. And what if, after the agreed upon time expires, you can buy the equipment for the remaining value, return it, or continue to use it under new (less expensive) terms? Is this a deal you would go for?

Increasingly, vineyard and winery owners and managers are choosing to lease new or used equipment over purchasing — barrels, tractors, presses, bottling lines, and much more — in order to enjoy just these benefits. PWV discussed the ins and outs of leasing with several experts in wine industry leasing to provide the information you need to shop effectively for a lease.

What is a lease?

"A lease is nothing more than a long-term rental," says Mari Featherstone, partner in LeaseMark, Santa Rosa, CA. An independent lessor, LeaseMark handles the leasing portfolio for National Bank of the Redwoods, a Sonoma County-based regional bank. "The difference is that rentals are usually month to month and leases are for a minimum of 12 months."

"With a lease," adds Linda Comet Koretz, vice president and leasing specialist for BankAmerica Leasing and Capital Group in San Francisco, "the lessee trades off the benefits of ownership to the lessor for a lower cost over the term of the lease."

Typically a lease runs for 12 months to five years, though "winery equipment lends itself to longer-term financing," explains Koretz, because of its long life.

Leases have several variables, but the three basic variables are the term or length of the lease, the payment, and the buyout. The buyout (or purchase option) amounts to how much of the value of the equipment remains at the end of the lease. That’s the amount you will have to pay if you want to buy the equipment, though you always have the option of returning it rather than buying it.

There are essentially two types of leases: the operating lease (also called a true lease or tax lease) and the capital lease (also called a finance lease), which is really a conditional sales agreement.

In an operating lease, explains Featherstone, "you agree to a specific payment for a specific time, and the buyout will either be fair market value or 10% based on the original cost of the equipment. Fair market value (FMV) is sometimes set at 15% or is truly the fair market value." How the lessor and lessee determine what the FMV is at the end of the lease is one of the lease variables.

In a capital lease, she says, "you agree to a specific payment for a specific time and agree to purchase the equipment at the end. Under the terms of a capital lease, you will pay essentially the full value of the equipment over the lease period, and you’re given the option of buying the equipment for $1 at the end of the lease. This is called a dollar buyout option. A capital lease is a conditional sales agreement and really more like a loan."

"The federal government sees a capital lease as financing for tax purposes and not as a true lease," adds Bill Volpa, vineyard and winery specialist with Comlease USA in Fresno, CA.

What are the benefits of leasing?

Leasing offers several benefits. One of the most important for many lessors is 100% financing, requiring no capital investment. "Often producers who need to add equipment would rather spend available capital for more profitable purposes," points out Paul Lamothe, regional sales manager for Farm Credit Leasing in Sacramento. His company is the leasing division of the Farm Credit System. Leasing requires a much lower initial cash outlay than purchasing with a loan, which may demand a down payment of 20% or more.

"Leasing is a way to manage your cash," says Jim Taylor, leasing agent with Hansel Leasing in Santa Rosa, CA. "Payments can be timed to coincide with your cash availability, and they may be monthly, quarterly, semi-annually, or at customized intervals," adds Lamothe.

Leasing also offers tax benefits, but the leasing experts are quick to insist that before you lease, you should check with your accountant. An accountant will help you determine which type of lease will give you the best tax advantage and whether leasing would give you any advantage at all.

In general, says Lamothe, "True lease payments may be 100% tax deductible. Therefore producers who have a tax liability can use leasing to obtain larger deductions each year of the lease." Though payments for capital leases are not tax deductible, with these leases you still get the same depreciation and interest-expense deductions on your taxes that you would have gotten if you had obtained a loan on the equipment, meanwhile, you’re enjoying the benefit of 100% financing. In addition, if you decide to buy the equipment at the end of the lease, you then get to depreciate it again as purchased used equipment.

Lease payments are generally lower than loan payments for purchased equipment. "Lease payments cover only the depleted value of the equipment, not the full acquisition cost," explains Lamothe. "And the future purchase value is guaranteed, because it must be stated in the lease," adds Taylor. Since the buyout price is set in advance, the lessee benefits because the price does not reflect the economic inflation that occurs during the life of the lease.

"Leasing doesn’t tie up your credit lines," says Featherstone. Taking out a loan to buy equipment eats into your available credit.

Will you qualify?

Leasing particularly appeals to start-up businesses that don’t have the cash for a down payment and may have already borrowed up to the limit. Such wineries or vineyard companies may well still qualify to lease, however, they will be likely to pay more for it. As in all lending transactions, credit worthiness is the surest way to qualify for a lease, and companies that can demonstrate a good credit history and profitability may save as much as two to three percentage points on their lease.

BankAmerica "needs to see that we have a credit-worthy borrower," says Koretz. The minimum lease her department will handle is $50,000; there is no maximum. To qualify for a lease of any amount, the lessee will have to provide three years of operating statements, sometimes backed up by tax returns. "Typically, we don’t lend to a start up without additional collateral support."

At Comlease USA, Volpa says, "For a small transaction $2,000 to $75,000, we only need an application, including the winery’s bonded status and credit history. But for larger transactions we need a full financial package. Everything boils down to credit worthiness and the ability to pay back debt."

Reading the fine print

When you’re negotiating a lease, there are several issues to be sure you understand and accept before you sign. "Sometimes people are surprised at the end of the lease because they didn’t understand what the terms meant," cautions Featherstone. Take the usual care when signing any contract to insure that all the terms are spelled out as you agreed to them.

• Costs: "Up-front costs usually include document processing fees, which are typically $100 to $500 depending on the cost of the equipment and the amount of paperwork," explains Featherstone. These costs include processing fees, title search, the cost of filing a lien against the equipment, and sometimes an application fee. In addition, most leases require an initial outlay of first and last month’s payment or first month and a deposit (which is equivalent to one month’s payment).
"Make sure that what you’re signing is the actual cost of the equipment. You’ve negotiated the price, and you need to be sure it’s reflected in the lease," Volpa suggests.

• Disposition and purchase option fees: "Vehicle leases have purchase option fees — an additional fee to exercise the option to buy at the end of the lease. These vary from lease to lease," advises Taylor. "Most lease companies have a disposition fee at the end of the lease, which they charge to dispose of the vehicle if you don’t buy it."

• Fair market value buyouts: Many leases place the cost of the buyout (purchase price at the end of the lease) at fair market value (FMV), but how that value is determined can vary markedly from lease to lease. "FMV is the equivalent of a retail price between a willing buyer and a willing seller," explains Koretz. It can be determined by consulting printed valuation guides, by an appraiser, or by consulting used equipment dealers, for example. Some leases allow lessees to bring in their own appraisals. Most leases set either a cap or floor on the purchase amount.

"I like to cap the FMV at not to exceed 20%," says Volpa. "Some equipment, such as tanks, will still be worth a significant percentage of what they were bought for at the end of the lease. Without a cap, the lessee would have to pay what they’re worth, which may still be 50% of the purchase price. Except for barrels and hoses, winery equipment lasts for many years, so I try to make sure my customers know exactly what’s going to happen at the end, and I write my leases to protect them."

• Insurance, maintenance, and mileage: As the holder of the equipment, you’ll be expected to protect the value of the lessor’s property with insurance and appropriate maintenance. The lease will provide for what penalties you’ll pay if you do not. Be sure you understand what returned condition is expected on the equipment. "On a vehicle lease, be sure you know what the excess mileage charge will be if you go over the agreed mileage," recommends Taylor.

• Prepayment penalties: "Lessors have costs that have to be recovered," points out Koretz, so there will be a cost if you terminate the lease early. In some cases, prepayment may not even be an option. You’ll also want to understand how the residual value would be factored into any prepayment calculation.

• Residual or buyout options: "Have a good understanding of how the residual is handled at the end of the lease," urges Lamothe. "We have a terminal rental adjustment clause, commonly used with leasing vehicles. When the payments have all been made, and the vehicle is returned, if we sell the equipment for less than the agreed-upon residual, the customer has to pay the difference. Of course, if the equipment sells for more than the residual, the customer gets the difference."

• Restrictions on use: Be aware that there will be limits on what you can do with the equipment once you have it. You can’t cannibalize it for parts, for example, and the lessor may not let you move it. "For a true tax lease, the lessee can’t move the equipment out of the country without affecting the lessor’s tax benefits," says Koretz. In addition, the lessor wants to know where the equipment is at all times for property (tax) management.

• Tax indemnification: "The lessee could be responsible for indemnifying the lessor against legislated changes that affect the lessor’s tax benefits," notes Koretz. That means changes in the tax code (such as the tax rate or amount of deduction possible) may affect your lease payment.

• Term: Be sure that the term on the lease agrees with what you think you’re buying, and be aware that some lessors require you to contact them to renegotiate the lease when the term is up. If you keep paying beyond the lease term, you may automatically re-up for another year at the same rate.

Flexible payment schedules

Though most lessees opt to make their lease payments on the traditional monthly basis, the wine industry is such a cyclical business that the potential flexibility of lease payment schedules can be particularly appealing. Not all lessors offer all options, but lessees can elect to have step leases, where, for example, the payment on a four-year lease is at one level for the first two years and then goes up or down for the next two years.

"If you have more cash in summer and less in winter," suggests Featherstone, "you might have a payment that is half in winter and doubles in summer." Some lessees pay in advance once, twice, or four times a year. "There is extra work involved in billing differently," she admits, "so these leases may cost a little more."

What kind of equipment can be leased?

"Farm Credit Leasing will lease virtually any type of equipment used in agriculture with the exception of airplanes and hazardous waste containers," declares Lamothe. The other experts agree that nearly any kind of equipment can be leased (including airplanes). In the wine industry, people most often lease trucks, tractors, gondolas, office equipment, tanks, bottling lines, and barrels. Farm Credit reports that its leases break down into the following categories: 7% transportation; 36% plant/ processing equipment; and 57% field equipment.

Leasing companies are also quite open to leasing used and custom-built equipment. Taylor says Hansel requires a third party appraisal on used equipment, so his company and the lessee can be assured that the value of the equipment is sound.

Even if a winery or vineyard owner has already bought a piece of equipment and is regretting not having leased it, it can be leased. Lessors will often buy equipment from you and then lease it back to you.

Lessors do have some special concerns with leases on custom-built equipment. They have to consider whether the equipment will have any value to other buyers at the end of the lease, and if the equipment was built into the facility to the extent that it couldn’t be moved if it had to be repossessed. In either case, strong credit-worthiness on the part of the lessee can usually overcome these concerns.

Though nearly anything can be leased, the lease terms available will vary widely with the type of equipment and how long it retains its value. Barrels, for example, have a short life span for ageing purposes. "Wineries use barrels differently, so how the winery uses the barrels and how they rotate them will affect the term and residual," explains Taylor. "Typically, we lease barrels for three years with a $1 residual. But some wineries use barrels for storage, for example, and that may affect what type of lease we’re willing to do. We can tailor the lease to how they do business."

Even more than barrels, computer equipment quickly becomes obsolete. As a result, lessors generally configure their leases to get the value of the equipment during the term of the lease. "A key component of our pricing is the expected value of the asset at the end of the lease," explains Koretz, "if there isn’t likely to be much residual value, then the running rate of the lease will be higher to the lessee than the running rate for assets that retain value over the lease term."

What about other costs?

Loans for purchase often include associated costs (called soft costs), such as installation, shipping, taxes, and computer software, for example. A few companies say they rarely will include these costs in a lease, but Koretz believes that it’s part of the cost of doing business. "We include soft costs, typically up to 20% of the total equipment line. It doesn’t enhance the residual, but customers want these costs covered, and we tend to finance them." Other companies cover soft costs up to 10% or 15% of the total.

Lease lines of credit

Not all companies do lease lines of credit, but they can be of great advantage to the lessee. "A lessee can pre-qualify for a certain amount," explains Volpa, "and they draw down against that credit as their equipment is delivered. These are usually good for about a year, though we may need to recheck financials at six months." The advantage is that you know the rate and don’t have to make several applications.

Lamothe cites a mobile bottling line that Farm Credit is funding as an example. "Several vendors are working with the winery to supply the equipment to be used. We provide interim funding as the deliveries are being made, and the customer has agreed to pay interest on the advances. We make payments to the various vendors when our customer gives us a written OK with the invoice attached. It’s essentially a construction loan with interest accruing until the unit is done. When it’s done, we will bill the customer for the interest, and the first lease payment is due."

BankAmerica does equipment lines often. Koretz points out that specifics of financing packages are approved for up to a year with pricing adjusted via an index method for multiple delivery dates.

Is leasing for you? Ask your accountant

Experts agree unanimously that you must see how leasing fits in your company’s financial picture before you will know whether it is a good choice for your winery or vineyard operation. "If you’re considering leasing, talk with your accountant to determine if it’s right for you," urges Taylor.

"Frequently vineyard and winery owners bring their accountants with them to discuss the lease," says Koretz, "and if not we sometimes ask if they want us to talk to their accountant."

The big picture

Leasing is increasing in the wine industry, though the experts agree that there’s an ebb in leasing when cash is abundant and a flow when cash is tight. Still, the USDA reports that only about 20% of all agricultural producers in the U.S. lease, though about 40% of larger agribusinesses and cooperatives lease. Farm Credit Leasing reports that it has seen a 750% increase in lease placements in four years, in part due to the company’s increased interest in providing leases.

"While leasing is growing dramatically in popularity with the more sophisticated producer," says Lamothe, "I still find that often vineyard and winery owners are not familiar with or understanding the lease product. Their acceptance of leasing changes once they become more informed about this alternative financing tool."

Featherstone agrees: "People in general are not taking advantage of leasing because of a lack of understanding and a sense of mistrust. Oftentimes, people have had poor experiences and don’t want to try again." In the past, experts say, when the leasing industry was relatively new, some lessors pushed too hard to sell leases and not hard enough to educate consumers. As leasing has matured, lessors have recognized that they benefit most by helping customers find the financing vehicle that works best for them.

Leasing has also been affected by wine industry trends. "During the past five to seven years," Koretz recalls, "there has been a strong interest in developing new vineyards, and wine industry capital has been going in that direction. As those vineyards mature, there is a greater focus on providing the financing for the new winery production equipment that is required to handle the increased grape production."

Ray Garassino, treasurer at Robert Mondavi, Oakville, CA, says the company uses leasing as one of its financial tools. "Look to lease financing as one of the alternatives of meeting your business’s financial needs. And understand the terms of a lease before you enter into it. It could be a great deal or a lousy deal."