• Blue Willow Group

The Opportunity Cost of Funds and CAPEX Acquisition

Many companies have equipment needs. It’s not if you’ll need equipment - it’s when. Some industries are more equipment intensive than others - manufacturing, wireless networking, transportation, etc., but all companies utilize computers, office equipment, furniture, etc. After an equipment need is identified, “how are we going to pay for this” is a question shortly to follow. If your team needs a couple of laptops, you may opt to use your company credit card or cash. When needs are more significant, say in the tens to hundreds of thousands or into the millions of dollars, it makes sense to review all available capital options to ensure the right fit for your needs.

For the purposes of discussion, let’s assume your company needs to acquire $2MM worth of manufacturing equipment which will increase production capability, expand market share, and is necessary to meet revenue projections. Let’s review the most common options for acquisition and the opportunity costs associated with each.

Cash - If your company has plenty of cash on the balance sheet, it can be tempting to simply pay for equipment outright and get to work. This strategy has benefits - the company owns the equipment outright. You are not responsible for monthly payments and there is no interest to be paid or additional debt on the balance sheet. There are some considerations regarding the opportunity cost of using cash. First and foremost - cash spent on equipment can’t be deployed in other areas of the business. Opportunities to invest in sales, marketing, IP, etc. may be delayed or missed if the cash necessary to capitalize on them is unavailable. Another consideration is any existing senior-secured debt your company may have (bank line of credit, term loans, etc.). Most of the time, senior-secured debt is secured with an all business assets (ABA) or blanket-lien filing. Typical blanket-lien language includes statements like, “all equipment now owned or hereafter acquired…” or similar. In other words, even though you purchased the equipment subsequent to getting your loan or line of credit, the lender may automatically have a lien on your new equipment if blanket language is present. Most of the time this isn’t an issue, but should at least be evaluated prior to purchase in the event this could be problematic at a later date. Also - chat with your accountant if need be on this point, but as companies become profitable, offsetting tax exposure with expenses can be important. Paying cash for equipment eliminates interest expense for the acquisition and therefore eliminates the offsetting deduction.

Term Loan (senior-secured) - Term loans are a viable option to acquire equipment and offer a high level of flexibility. These loans are typically senior secured (with an ABA filing), and while the equipment is covered by the lien, the use of funds is less stringent than a CAPEX specific loan. This can be a benefit if there is a high level of soft cost (installation, training, etc.) included with the acquisition. Most CAPEX lines will cover 10-20% of soft-costs, but if costs exceed this threshold or if some of the funds need to be utilized for other non-equipment related purposes, a term loan can be a good fit. The opportunity cost here really centers around the senior-secured aspect of the structure. This can be problematic if you already have a loan or LOC which is senior secured and if one of the lenders is unwilling to subordinate. Adding a refinance of an existing facility to a term loan is possible, but can complicate the process.

CAPEX Lease or Loan (secured by the equipment to be purchased) - CAPEX lines are loans and leases designed to be secured by the equipment purchased. Structures include loans and leases. The difference between a loan and a lease is ownership - when you secure a loan for equipment, you purchase it in the name of your company and pay the lender for the use of the money. In a lease structure, the lessor owns the equipment and rents it to you. In this case the company pays for the use of the equipment. Leases have end of lease options to determine what happens to the equipment. Most CAPEX leases will have a stated buyout, either a percentage of the equipment cost (20% as an example) or will be labeled as, “Fair Market Value” (FMV). End of lease options include purchasing the equipment for the agreed upon buyout, extending the lease by continuing to make monthly payments, or returning the equipment to the lessor. A CAPEX lease or loan is often the best solution for a company when they need to acquire a significant amount of equipment. CAPEX specific facilities don’t interfere with existing debt structures due to being secured by the equipment to be purchased. As important - they don’t interfere with future debt facilities as they aren’t senior secured with ABA filings. When we speak with clients who need to acquire equipment, we strongly suggest CAPEX specific lines due to the minimal opportunity cost of these kinds of funds. CAPEX facilities allow clients to acquire the equipment they need without tying up cash or dealing with existing and/or future ABA issues with senior-secured term loans.

Equipment acquisition is critical to all companies on some level. Evaluating options and opportunity cost will ensure the right fit. As always, we’re happy to discuss this or any other questions or needs you may have regarding the venture debt capital markets. All the best!


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