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Finance: Weighing Your Options

Paul Partyka |

CHICAGO — “What type of equipment do I need to purchase in order to stay competitive?” It’s the question that operators face on a consistent basis. Deciding how to pay for everything can also be a challenging question. A little financial information can be helpful.Todd M. Rice is manager of financial services for Alliance Laundry Systems LLC, manufacturer of commercial laundry equipment. Rice manages a securitized Laundromat equipment loan portfolio for the company.Rice recently addressed a host of financial-related questions.Q: When an operator plans to purchase some equipment, what questions need to be addressed?Rice: The only question that profitable operators should be asking is: “Will this new equipment increase my turns-per-day as compared to the equipment that it is replacing?” If the answer is “yes,” the operator should buy that equipment. Even if the increase in turns-per-day is a quarter turn per day compared to the old equipment, the answer should still be “yes.” The reason is that this increase in turns will be magnified in determining the value of the operator’s business.When buying new equipment — the revenue driver of the business — operators need to focus on increasing the value of their laundries, as that is where the long-term payoff lies. All too often, I speak with laundry owners and their primary concerns turn to price or interest rates. These should not be the overriding factors as they have nothing to do with how your laundry is valued.Laundromats are valued on multiple(s) of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) or earnings before debt service. Debt is eliminated in valuing your business. Therefore, using leverage (or debt) to drive up EBITDA can pay off for the profitable operator. Not only do you get a new marketable product to go against the competition, but you improve the value of your store exclusive of the cost. Distributors know this and have done an excellent job of providing quality financing opportunities. This allows the owner to affordably drive up profitability and the value of their business.Q: When looking at payment options (cash, leasing, financing), which one is the most prevalent in the coin laundry industry?Rice: In my opinion, the Laundromat owner has chosen financing as the primary payment option. It has consistently provided the owner with the most flexibility in terms of repaying the loan, refinancing the loan and providing the owner with tax advantages associated with deductions for interest and depreciation.Q: Discuss the pros and cons of a cash purchase.Rice: The benefit of a cash purchase is eliminating the cash outlay related to a monthly debt obligation. Any increases in profit will go directly to improving the net income and liquidity of the business. The disadvantage is the opportunity cost of investing cash that could be spent elsewhere in your laundry. My reasoning is the operator does not improve the value of their business any more by paying cash than if they were to finance the equipment. Therefore, the opportunity cost — using this cash to invest in marketing, develop a second store or make a different investment — is great.Q: Discuss the pros and cons of financing.Rice: The pros of financing are the storeowner takes direct ownership of the equipment, typically finds the lowest cost of money, and gets the tax benefits related to depreciation and interest. These tax benefits are critical for owners to evaluate as they can further enhance their return on investment. Other benefits include more flexibility (fixed or variable rate options) and limited or no prepayment penalties.The cons are bank financing or SBA financing require an extensive approval process and charge higher fees. The approval process can sometimes take weeks to complete and fees can be as high as 200 to 300 basis points for depreciable assets. This has been offset by an array of manufacturer-based programs that allow storeowners a much more streamlined approval process and lower fees.Q: Discuss the pros and cons of leasing.Rice: Leasing provides the storeowner with a variety of options that will fix the payment. This is beneficial for budget and planning purposes. In addition, there can be tax benefits to leasing that a storeowner will want to review closely with his/her accountant.The cons to leasing usually are in the details. Many leases require a significant prepayment penalty that penalizes an owner if he/she wants to prepay or sell the store as a result of its strong performance. Also, depending on the type of lease you have, you may not actually own the equipment and may not be allowed to utilize depreciation benefits for tax purposes. Finally, leases may come with automatic renewal clauses that require the lessee to notify the lessor of lease expiration and pay the buyout cost. Failure to do so could mean extra costs for the lessee such as automatic renewal.Q: Looking at the prime rate, is now a good time to buy?Rice: Variable-rate financing is traditionally the operator’s lowest cost of financing. However, this financing has increased in cost during the last couple of years. The prime rate has increased 17 consecutive times through July 2006. The Fed has since held steady on interest rates. If you believe most of the damage has been done, now may be the time to buy and execute a variable rate contract. It all depends on your appetite for risk.I am certain that storeowners who used fixed-rate financing two years ago have been pleased. However, I am not so sure storeowners who are locking in rates today will feel the same way two years from now. It may be a case of getting in on a good thing too late; especially if you think the bulk of damage on rising interest rates is done. However, operators should never delay the purchase of replacement equipment due to interest rates. Interest rates are irrelevant in valuing a store. The driver should simply be: Can new equipment improve my turns-per-day?Besides the value concept, the fall can be an excellent time to buy, as many distributors and manufacturers have traditionally provided additional incentives such as product rebates and financing promotions.Q: What else could influence buying decisions?Rice: In addition to improving turns-per-day, rising utility costs and equipment prices can influence buying decisions. The industry has done an excellent job of proactively designing new products and features for owners to continue to address rising utility costs. These include: washers with faster spin speeds and variable rate pricing plus larger, energy-efficient dryers with new price points.For those operators who use price as a driver, they may want to consider the continuing fluctuation in raw materials pricing and buy now. Raw materials such as steel, copper and nickel have, over the past several years, risen exponentially. The global economy is putting stress on these materials that manufacturers have never seen before. No one really knows how high these raw material prices may go. If you are concerned with price, you may want to hedge your bets and buy sooner rather than later.Q: Is section 179 (a tax break) still in play for operators?Rice: My understanding of the section 179 bonus depreciation is that it is still available through 2007, per the Job Creation Act of 2004. I would strongly recommend that any operator work with his/her CPA on using this deduction as there are certain qualifications and special phase-out rules that apply.Q: What other tax breaks might be available?Rice: An operator always will have the non-cash benefit of deducting depreciation costs associated with the purchase of new equipment. For existing profitable stores, there are some accelerated depreciation methods that can make an equipment purchase affordable. Contact your CPA to learn more about these benefits.Operators located in any of the “GO Zones” or Gulf Opportunity Zones may want to read through IRS publication 4492. It provides additional tax incentives to those affected by the hurricane damage from 2005.The IRS Web site can also be a great resource. The tax code is complex, and an operator should seek the assistance of a professional to help them navigate through state or local tax breaks.Q: Why not use a bank to finance a deal? Why go to a manufacturer/industry finance company?Rice: Using banks for financing laundries can be time consuming. In addition, many banks do not provide asset-based lending or, if they do, they do not provide as favorable terms as a manufacturer-based program would. A typical local bank may finance 70 percent of equipment cost for five years. In many cases, banks will charge fees as high as 300 basis points that can increase the APR on the loan by 0.5 percent. The bank may bump up the finance amount if the operator provides additional enhancements such as real estate or their personal home.Manufacturer-based programs are built on quick response times and high levels of service. They are typically more aggressive on financing as they tend to have more industry knowledge than a bank. Many manufacturer-based programs will finance up to 100 percent of equipment list price with terms up to seven years and fees as low as $150. A hidden benefit of manufacturer-based programs is that if they service the loan, you get to deal with people who actually work in the laundry industry and understand your business. In addition, many manufacturers will run seasonal promotions that offer favorable financing rates.Q: What questions should an operator ask when shopping for finance firms?Rice: A financing source is going to compete on the same items that any company would: product features and benefits, pre- and post-sale service, pricing and historical performance. An operator should always research finance firms’ programs and benefits, published interest rates, whether or not they service the loan or lease after it is made, and how long they have been in business. Your local distributor is the best resource for information on manufacturer-based programs, local banks and leasing companies. They should be able to get you in touch with a financing source. 

About the author

Paul Partyka

American Coin-Op

Paul Partyka was editor of American Coin-Op from 1997 through May 2011.

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