What is a lease?
A sale and leaseback is an agreement whereby the seller of an asset leases the asset to the buyer. In a sale and leaseback agreement, the details of the agreement, such as lease payments and the term of the lease, are made immediately after the sale of the asset. Essentially, the seller of the asset becomes the lessee and the buyer becomes the lessor.
How leases work
Most often, a business needs capital to grow. Companies acquire capital either by debt, by equity financing, or by both. The debt must be repaid and entered in the company’s balance sheet as debt. Equity does not need to be repaid, but it comes at the expense of ownership. A sale and leaseback allows that to happen.
Types of sale and leaseback
The most common users of sale and leaseback agreements are builders or businesses with high cost capital assets. A sale and leaseback arrangement is useful when a business needs to use the cash invested in an asset for other investments, but the asset is still necessary to operate.
Sale and leaseback agreements can also provide the seller with additional tax deductions. The lessor benefits by receiving a guaranteed lease with stable payments for a specified period of time.
Equity does not need to be repaid, but comes at the expense of ownership
Although sale and leaseback transactions have a different accounting treatment for debt, they are generally not considered to be financing and therefore remain off balance sheet. This is why some analysts add capitalized leases to long-term debt when they try to get an overview of the company’s total debt.
Examples of sale and leaseback
A sale and leaseback agreement, also known as a sale and leaseback, is neither debt nor equity. In fact, a sale and leaseback is more like a hybrid debt product. The company does not increase its debt but access capital by selling assets.
It looks a lot like the corporate version of a pawnbroker transaction. The business goes to the pawnbroker and in exchange for a valuable asset, receives a certain amount of money. The only difference is that the company does not expect to buy the asset.
For example, suppose Company A needs additional capital to pay employees and contractors but cannot access the debt markets due to bad credit. The company sells equipment to an insurance company, it being understood that the equipment must be immediately rented and resold to the seller.
As long as the amount billed for this service by the insurance company does not exceed the interest rate on high interest loans, sale and leaseback is the best option.
Key points to remember
- A sale and leaseback can be a good way to use your tools or products, but with a lower capital commitment.
- Sale and leasebacks are most often found in businesses with high cost capital assets that they cannot easily unload.