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Written for GE Corporate Financial Services by Knowledge@Wharton

Copyright ©2003 GE Capital Commercial Finance, Inc. All rights reserved

GE Corporate Financial ServicesgTable of Contents

Who We Are . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

Four Principles to Consider Before Choosing a Lender . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Optimizing Your Balance Sheet to Achieve Sustainable Growth . . . . . . . . . . . . . . . . . . . . . .11

Asset-Based Lending: What it is And Why it May-or May Not-

Be Right for Your Company . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Corporate Restructuring-A Possible Alternative to Chapter XI . . . . . . . . . . . . . . . . . . . . . . . 21

The Right Way - and Some Wrong Ways - to Make an Acquisition . . . . . . . . . . . . . . . . . . . 25

The Corporate Conundrum-Is It Better To Buy An Asset Or To Lease It? . . . . . . . . . . . . . . .29





GE Corporate Financial Servicesg



Who We Are

About GE Corporate Financial Services

One of the fastest growing GE Businesses, Corporate Financial Services is a leading global provider of inno-

vative financing solutions, primarily for middle-market non-investment grade companies. GE Corporate

Financial Services specializes in loans greater than $2 million.

Corporate Financial Services was created in 1992 and is headquartered in Stamford, Connecticut. Consisting

of eight customer-focused business segments, Corporate Financial Services has over $28 billion in assets, and

employs more than 2,800 professionals worldwide.

About Knowledge@Wharton

Knowledge@Wharton is a bi-weekly online resource that offers the latest business insights, information and

research from a variety of sources. These include analysis of current business trends, interviews with industry

leaders and Wharton faculty, articles based on the most recent business research, book reviews, conference and

seminar reports, links to other web sites and so on. The web site presents information in layers so that users

can pursue their interests to whatever depth they wish. An in-depth searchable database of related articles and

research abstracts allows access to information through simple mouse clicks.

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GE Corporate Financial ServicesgNeed a Loan? Four Principles to Consider

Before You Choose A Lender

Picture this: A real estate developer from New York City visits a Philadelphia suburb, sees a building for sale

at an attractive price and is tempted to buy it. He calls his banker, only to be told that the institution isn’t mak-

ing real estate loans. What should he do? Or consider this: While browsing through a business daily, a retail

store owner learns that a bust dot-com’s product inventory – worth $10 million – is on sale for 20 cents on the

dollar. That would be a bargain, if she could only raise $2 million to grab the opportunity. To whom should she

turn?

Situations such as these constantly arise in business. Unfortunately, solutions are rarely available easily – espe-

cially when deadlines are tight. The U.S. economy may be slowing in the aftermath of the tech-stock collapseon Wall Street, but that does not signify fewer business opportunities. In fact, an economy heading toward

recession sometimes generates more opportunities for savvy companies. The key question such companies

face is: How can we raise capital when we need it, so that we can respond rapidly to opportunities as they

come along?

The answer is both complex and multi-layered, according to experts at the Wharton School of the University

of Pennsylvania and GE Commercial Finance. They point out that picking the appropriate lender for a particu-

lar capital requirement is among the most important choices a borrower can make. If the choice is made wise-

ly, not only will it facilitate opportunistic deals – such as snapping up real estate or product inventory at lower

prices – but it will also establish a strategic relationship that can help the company achieve its long-term goals.

In making these decisions, it is important to have a general understanding of the significant changes that have

occurred in the U.S. business-lending marketplace during the last two decades. As has been widely noted by

banking, finance, and academic experts, a large segment of the business credit market has shifted from banks

to commercial finance companies. Numerous factors have played a role in this shift:

• Financial deregulation created more competition between bank and non-bank lenders

• Risk-based capital regulations increased capital requirements for the banking industry

• Banking consolidation greatly reduced the number of commercial banks

• Substantial loan losses during the 1987-93 economic downturn and the need to strengthen capital positionsled many banks to tighten terms and standards for underwriting business loans

• Technological changes in information storage and communications have enabled finance companies to gain

access to money and capital markets.

Concurrent with these changes, financial assets at commercial finance companies have grown dramatically,





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increasing from $197 billion in 1980 to $956 billion in 1999.1

Finance companies are now major suppliers of credit to American business and provide important alternative

sources of funding to the traditional commercial banking lenders.

Keeping this background in mind and paying attention to four related principles can help borrowers avoid

errors in choosing the right lender for a transaction.

Examine your goals and needs.

“Know thyself,” said Shakespeare, and that is just what a company wishing to choose a lender must do.

Specifically, this involves analyzing both the type of loan the borrower needs and its size. In selecting a fund-

ing source for a particular transaction, borrowers should take into consideration current capital needs, as wellas future business plans.

For example, if a company needs a revolving line of credit, real estate financing or structured financing to re-

capitalize, financing decision makers need to know that different lenders specialize in these types of lending.

“Banks do not typically offer a long term, fixed rate real estate loan product.,” points out Bill Gregory, Senior

Vice President of GE Business Asset Funding. “If you need a revolving line of credit, you typically would not

go to a term lender. Some companies are experts in these businesses and others are less focused on them. Once

you have identified your company’s needs, that knowledge will direct you to the -type of lending institution

that is best able to provide an appropriate solution.”

The size of the loan is another key factor. A large real estate investment trust that needs $500 million for long-

term development projects may be able to raise capital on Wall Street. The same option may not be availableto a medium-sized property developer who needs $2 million to $10 million to complete a transaction. The size

of the funding requirement – and also that of the borrowing company – help determine what kind of lender the

borrower should consider.

Understand the regulatory environment.

Although this is a complicated exercise, recognizing the regulatory factors shaping financial markets is as crit-

ical for a borrower as understanding the company’s goals and needs. The financial environment has been

going through a period of rapid change. Historically, the Glass-Steagall Act of 1933, which was intended to

calm the fears about bank failures following the Great Depression, has shaped the regulatory environment of the financial services industry today.

In recent years, however, according to research by Anthony Santomero, former director of the Wharton

Financial Institutions Center and David L. Eckles three forces have “conspired to make the restrictions of the

Act increasingly irrelevant.” These forces, according to Santomero, include technological innovation, regulato-




ry circumvention, and new delivery mechanisms. These have led to changes in the market infrastructure and

altered the competitive dynamic between banks and finance companies such as GE Commercial Finance,

General Motors Acceptance Corp. and Ford Motor Credit.

One major effect of banking deregulation – a phenomenon that got a shot in the arm after the Financial

Modernization Act was passed two years ago – has been to spur bank consolidation. This development has

important implications for companies that wish to borrow funds from banks. From 1987 to 1993, the banking

industry consolidated radically through nearly 3,000 mergers. These mergers sharply reduced the number of

small banks, which tend to specialize in lending to small and medium sized business borrowers. 2Meanwhile,

finance companies continued to develop their traditional core asset-based customers in the small and middle

market. As a result, it has become more difficult for mid-market borrowers to obtain, maintain, and extend

levels of funding from major bank sources and relatively easier for finance companies to serve this market.

As institutions that raise deposits from the public, banks are closely regulated by government agencies. Thishas crucial implications for potential borrowers. “Banks have lending limits, and they have to stay within cer-

tain financial ratios,” explains Gregory. This makes it difficult for these institutions to explore market opportu-

nities as freely as they might like. “For example, banks sometimes contact us when they are ‘out-of-ratio’ on

investments such as real estate mortgages,” he adds. “Regulating agencies, which were lax during the past sev-

eral years, are beginning to tighten up again. Some banks are trying to be proactive by selling pieces of their

portfolios in order to bring ratios back in balance.” Borrowers must recognize these possibilities when choos-

ing a lender.

Several real estate companies felt the impact of bank regulatory pressures during the recession of the early

1990s. Stung into action by massive S&L failures following the real estate bubble of the 1980s, bank regula-tors introduced tough lending requirements that left large numbers of developers scrambling for capital.

“Banks began to call loans that were performing and pull credit lines from borrowers so that they could bring

their portfolios back in line with government mandates,” says Gregory. The borrowers that best survived these

traumatic times, he adds, were those that had strong relationships with both banks and finance companies.

Explore lending practices.

Borrowers must recognize that banks, finance companies, insurance firms, pension funds and other lenders

view borrowers in different ways. An important factor in choosing a lender involves understanding the lender’s

approach towards its customers. “In general, banks look for loans of a certain quality, and they set up a pass-

fail system,” says Gregory. “Either an application for credit passes or fails based on the bank’s lending crite-ria.” In contrast, finance companies generally set up risk-reward continuums, whereby loans are priced accord-

ing to their degree of risk. While this gives finance companies greater flexibility in making loans, it also has

helped support the view that loans from finance companies tend to be more expensive than those from banks.

The lending practices of different institutions are closely related to their exposure limits to various borrowers.

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This sometimes makes it difficult for a company to borrow more

from a lender. “Borrowers tend to overlook their total exposure with a lender. A borrower may have a $10 mil-

lion or $20 million credit line and they need to understand that the line is counted as part of their total expo-sure– even if the credit line is not fully utilized,” Gregory points out. “If the borrower’s business is growing,

and the company needs to increase its credit availability for working capital, it may run into a situation where

it hits an exposure limit.” Should that happen, the borrower could run into trouble.

Yet another aspect borrowers should consider is the extent to which the lender’s overall activities affect its

lending practices. Consider, for example, how diversification and specialization affect the practices of banks

and finance companies. As noted above, banks are subject to diversification requirements that proscribe con-

centrations of loans to single borrowers. This may prevent a single borrower from obtaining additional funding

from a particular bank. Finance companies, however, limit exposure according to internal risk management

criteria, which are often more flexible in extending multiple loans to credit worthy borrowers.

Also, be aware of the fact that banks serving small and middle market businesses may be geographically con-

centrated, tending to serve a broad range of borrowers in a given region. The larger finance companies, on the

other hand, tend to specialize in a certain industry segments or asset collateral groups on a national scale,3

and, as a result, are more familiar with the capital needs of the industries that they serve.

Jos. A. Bank Clothiers, for example, a men’s clothing company headquartered in Hampstead, Maryland, need-

ed a cash infusion to open 30 more stores to add to its existing 118. Company officials researched getting a

loan from the bank, as well as other finance companies, but ended up putting a mortgage on its corporate

office and distribution center through GE Business Asset Funding and securing a loan for $5.5 million. “Some

banks prefer to lend money against inventory, whereas GE Business Asset Funding specifically goes after real

estate,” explains David Ullman, Jos. A. Bank’s executive vice president and chief financial officer. “Because

they’re familiar with the type of asset if they ever needed to liquidate, they would know the value of the prop-

erty.”

Commercial banks play a valuable role as lenders, adds Ullman, who emphasizes that Jos. A. Bank still relies

regularly on its bank for non-real estate-related services. But whether a company is a $206 million corporation

like the clothier, or a small business, it often can benefit from the flexibility and expertise offered by non-bank

lenders.

Focus on establishing a strategic partnership.

A longstanding relationship with a lender helps engender trust and establishes a strategic partnership that can

reduce documentation and processing time. “Once you establish a relationship all the surprises are gone,”

Gregory explains. “At GE, our strongest accounts are our strategic partnerships – borrowers who understand

our needs just as we understand theirs.”



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When a company establishes a strategic relationship with its lender, it can ride out market turbulence more

easily than if it were to focus narrowly on one-off deals. For example, in 1998, when the capital markets went

haywire, several companies were left without sources of funding. At such times, lenders rushed to rescue bor-rowers with whom they had the closest relationships. GE, for example, “supported as many borrowers as pos-

sible,” says Gregory. “But we first assisted those with whom we had strategic relationships.”

In their effort to choose lenders—either finance companies or banks—borrowers should examine their busi-

ness operations much in the same way that they evaluate business risk from their customers. “If a company

gets 75% of its revenues from one customer, it would probably see this as a major risk,” Gregory points out.

“Should that one customer go out of business, they would lose 75% of their revenues. Borrowers should apply

the same philosophy to their lenders. If the lender has a change in its philosophy, borrowers may be adversely

impacted.”

Borrowers are busy people –and sometimes they may be tempted to act quickly in seeking financing. But theyare well-advised to carefully consider appropriate sources of funding. Business owners making financing deci-

sions should select the appropriate lender for a particular transaction, understand the impact of regulation, spe-

cialization, and diversification on lending practices, and establish a strategic relationship with their lenders of

choice. Adhering to these principles will enable borrowers to focus on business operations.

1 U.S. Census Bureau, Statistical Abstract of the United States: 2000.p. 508,

2 Federal Reserve Bulletin, November 1996. P. 985

3 Simonson, Donald G. Business Strategies: Bank Commercial Lending vs. Finance Company Lending. April

1994. Pp. 12-13

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Optimizing Your Balance Sheet to Achieve Sustainable Growth

Can growth be harmful to your company’s health? The pursuit of growth, as measured by higher sales, is usu-

ally taken for granted in business. But growth for its own sake may not always be in a company’s best interest,

according to John Percival, a professor of finance at Wharton, and Scott Parker, a vice president of financial

planning and analysis at GE.

Percival believes that many companies that have either filed for bankruptcy or have had close encounters with

Chapter 11 are victims of trying to do too much, too fast. Like the proverbial tortoise that plodded its way past

the hare to win the race, a strategy that emphasizes profits over sales gains may yield positive long-term

results.

The battlefield of commerce is littered with companies that overemphasized sales growth beyond sustainable

levels. Consider, for example, the high-profile flameout of the dot-com sector, whose stock prices have

plunged 75% for the year as of May 31, according to The Industry Standard, a national magazine that covers

the New Economy and related issues. For Wharton’s Percival, though, the dot-com debacle merely scratches

the surface.

Percival points out that companies like Lucent Technologies, which recently saw its debt ratings cut to “junk”

status by Standard & Poors, and Winstar Communications, which recently filed for Chapter 11 bankruptcy

protection (and also filed a $10 billion lawsuit against Lucent) can trace at least part of their problems to their

fast-growth strategies.

Part of the challenge is to understand the necessity of managing growth, which can force CFOs to balance the

long-term health of their companies against the demands of Wall Street analysts who often look for quarter-to-

quarter expansion. Instead of a blind commitment to growth at all costs, however, Percival suggests an alterna-

tive known as Sustainable Growth.

An Emphasis on Profit Instead of Sales

“Simply increasing sales may not lead to long-term success, because the growth in revenue carries a corre-

sponding increase in variable costs for such things as production equipment, labor and inventory,” explains

Percival. “Instead, a company should concentrate on sustainable growth, which is characterized by first

increasing profit, and then retaining the earnings within the company.”

Finding a company’s maximum sustainable growth rate doesn’t have to be a hit-or-miss proposition. Percival

says a formula can quantify a company’s growth potential by considering the relationship between the return a

firm generates on its shareholders’ equity and the portion of its earnings that it plows back into that equity.

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“Sustainable growth boosts a company’s net equity, making it more

attractive to both capital and equity markets,” notes Percival. “Carefully streamlining a company’s balance

sheet, including shedding certain debt, re-allocating assets and elimination or reduction of non-earning assets,is one way to achieve sustainable growth.”

But before taking steps to optimize a balance sheet, finance executives should thoroughly comprehend the

finances of their company, the environment in which it operates and the types and cost of capital available to

it. And rather than taking a knee-jerk position against debt, Percival suggests that companies recognize the

positive role that debt can play in the value creation that underlies sustainable growth.

“Depending on the company’s circumstances, some types of debt are better than others,” he says. “It is impor-

tant to align the nature of your assets with similar liabilities. For example, short-term assets should not be

financed with long-term debt. The savings and loan industry borrowed short and lent long, but an uptick in

interest rates doomed the industry.”

Pairing off your assets and liabilities, however, may involve making some counter-intuitive moves.

Breaking Up May be the Right Thing to Do

Percival cites Marriott, the worldwide hospitality company, as an example of an organization that charted an

effective strategy. In 1993 the company split its operations into two companies—Marriott International and

Host Marriott—and loaded Host Marriott with most of the firm’s real estate holdings and debt. Marriott

International went on to engage in structured financing transactions, selling off substantial assets to passive

equity investors and then securing contracts to manage those very assets. While the sale of assets brought cash

in through the front door, the management contracts provided for a revenue stream over a longer-term period.

The principle behind the actions is what’s important, says Percival. “Optimizing a balance sheet through a

structured financing strategy may enable a company to identify business segments that may be of limited value

to itself, but for a variety of reasons may be worth a premium to other entities.”

In Marriott’s case, the company correctly determined that depreciation and other tax benefits associated with

its hotels would be worth a premium to high tax-bracket investors.

Debt and Taxes

Of course, asset disposal may not always be the best way a company can raise capital. For a variety of reasons

the market may not be right for a sale, or, in the case of service providers, there may not be much of a tangible

asset base to tap into. In such cases, debt or asset financing may be an appropriate vehicle to spur sustainable

growth, says GE’s Parker.



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“The cash provided by debt financing can open up expansion opportunities for a business,” he says. “But a

CFO needs to consider the relationship between the company’s debt and equity; and whether or not cash flow

and earnings can cover debt charges.”

Parker adds that the following issues should be considered within the context of balance sheet optimization

and cash flow:

• How much liquidity a company has. Cash on hand can be considered an offset to debt, and a firm can

leverage its cash position by taking on a controlled amount of debt.

• The cash flow impact of the tax deductibility of interest charges.

• Alternative debt financing, such as a balloon-payment or other interest-deferred loan that matches cash

outflow with cash inflow.

.

“For many companies, especially in the middle market, there’s a gap between the need for capital and the abil-ity to tap into secured financing or capital markets,” says Parker. “They need to be able to connect with Wall

Street and match up their needs with the return expectations of capital providers. Often, companies that are

new to the market will need to gain financial credibility, and a strong balance sheet can play a significant role

in the process.”

But the traditional methods of shaping up a balance sheet may not always be the right ones.

“Consider the example of Marriott,” he says. “The timing worked out favorably for the company when it

decided to spin off a portion of its assets. But what if the market wasn’t so favorable? Marriott might have

missed an opportunity.”

He says this is an example of a potential drawback to owning, instead of leasing assets.

“Part of a company’s approach to balance sheet management is deciding how to best deploy its capital,”

observes Parker. “Buying assets outright may be favorable if the opportunity cost of the funds is lower than a

lease alternative. On the other hand, if a decision is later made to dispose of the assets before their useful life

is extinguished, it may be more economical to finance or lease them”.

According to studies conducted by GE, the ability to dispose of assets, particularly non-core assets, is becom-

ing more important as companies seek to shore up their balance sheets through decreasing their excess lever-

age.

Dispose of Non-Core Assets, But Retain the Revenue Stream

According to Andrew Good, the strategic pricing leader at GE’s Commercial Equipment Financing business

unit, over-leveraged companies can choose from a variety of solutions, including optimizing their balance

13






sheet and raising funds by monetizing non-core assets, often

through a sales-leaseback transaction; or eliminating overhead costs through an outsourcing agreement. In

some cases, he adds, a combination of both approaches may be appropriate.

“A CFO often faces a decision tree, where he or she will consider a number of options,” observes Good.

“Deciding on the best strategy involves considering the company’s current position, and where management

wants it to be in the long term.”

Good notes, for example, that a company that must remain in compliance with financial covenants may wish

to manage its financial ratios by monetizing non-core assets.

“Often, the book value of a company’s assets are significantly lower than fair market value,” he says. “The

company may therefore realize a gain on the sale of those assets, which would strengthen the balance sheet

and improve financial ratios by transforming a fixed expense into a variable cost. Additionally, leasing theassets back from the buyer may enable the company to continue to maintain control over production or other

processes.”

A recent Wall Street Journal article notes that McDonald’s, which has extensive real estate holdings consisting

of the land on which its franchised units were built, is considering this strategy through the potential sale of

many of its properties.

“McDonald’s core business is food, not real estate management,” says Good. “The company could choose to

unlock the value of a non-core asset, real estate, by selling selected properties to a real estate investment trust

in a sales-leaseback transaction. Meanwhile the entire process is transparent to franchisees.”

In some cases, however, a CFO may recommend outsourcing non-core processes to a third party.

“CFOs have to ask if their companies should continue to perform certain functions,” says Good. “Outsourcing

operations to a third party that can manage those functions more efficiently and at a lower cost-while main-

taining the quality-may make sense.”

While Good distinguishes between monetization and outsourcing, he adds that a mix of the two strategies may

also make sense.

According to Claudia Stone Gourdon, managing director at GE’s Structured Finance Group, in this ‘blended’approach, non-core assets are generally sold to a third party (the owner), and then a contract is signed withanother company (the operator). Because of its own balance sheet considerations, the operator does not want

to own the asset but wishes to operate it under contract.

While the form of the contract will depend on the operator’s goals, the owner will establish a Special Purpose



14




Entity (SPE) and the company will sell the asset to the SPE. “The company and the operator then enter into a

long-term contract that typically includes a base fee that covers the capital charge and the services costs,”

relates Gourdon. “Properly structured, the transaction enables a company with a non-core asset to realize amonetary gain, while the outsourcing component enables the company to focus on its core business while

retaining some benefit from the sold asset.”

“Monetization and outsourcing, used either separately or, in some cases, together, represent a growing trend

and can benefit companies in the industrial sector by reducing excessive debt levels and fostering growth in

their core businesses,” says Gourdon.

“Companies today have a heightened awareness of the need to optimize their balance sheet as a component of

achieving sustainable growth,” adds Percival. “Now it’s a question of whether or not they will take the steps

that are necessary to implement it.”

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16




Asset-Based Lending: What it is And Why it May-

or May Not-Be Right for Your Company

At a time when many profitable companies have stumbled, posting net losses or weak cash flow, CFOs are

increasingly finding it difficult to obtain debt financing. But even as one door-cash-flow financing from banks-

closes, another one-asset-based lending-remains open, offering opportunities to mine a balance sheet for cash.

An Alternative Form of Debt Financing

When CFOs consider the growth plans for a company, they know that the well-planned assumption of debt

may be a key component of an effective strategy. But in the aftermath of recent economic turmoil and market

shakeouts, for many businesses—particularly those with high potential but less-than-stellar income state-

ments—the door to growth through debt acquisition remains firmly closed, barred by such lending require-ments as financial ratios and other hurdles associated with traditional, cash flow-based financing techniques.

There are alternatives, however, according to Howard Kaufold, an adjunct professor of finance at Wharton,

and Willie Brasser, managing director of middle market business at GE Commercial Finance. One in particu-

lar, asset-based lending, may be attractive to a wide spectrum of companies, from businesses looking to

enhance their working capital to ones that are operating under Chapter 11 protection. Asset-based financing

can smooth out cash gaps during business cycles, fund asset purchases and other acquisition strategies and, in

general, can give an enterprise the flexibility it needs to grow.

According to the Commercial Finance Association, asset-based lending is a $200 billion-plus market.

Manufacturers represent about 31% of the total marketplace, followed by wholesalers (28%) and retailers(17%). By revenues, most of these borrowers (71%) are under $50 million in size.

As its name implies, asset-based lending involves financing that is secured with an item of determinable value,

typically equipment or inventory (one subset of asset-based lending, factoring, is secured with trade receiv-

ables, but factoring is usually limited to industries such as furniture, textiles and garments). Because the nature

of the collateral—which is readily identified and can be easily recovered—offers some level of comfort to

lenders, qualified borrowers may be able to obtain competitive terms.

Pointing to one GE Commercial Finance client, a leading golf equipment company that stumbled in the midst

of an expansion program, Brasser says a balance-sheet oriented approach can uncover value that may not be

reflected on a P&L statement. “We don’t court risk,” he says. “But on the other hand we don’t have tunnel

vision when it comes to valuation.”

An Opportunity for Some Borrowers, but Not for All

The very characteristics that may let certain businesses qualify for asset-based lending also serve to exclude

17






others, cautions Kaufold. “Banks and other financial institutions

often have a formula that specifies the percentage of inventory or equipment against which they would be will-

ing to lend,” he says. “That is not very good news for service organizations, which may not have much in theway of tangible assets. Consequently, a significant number of companies may be effectively shut out of this

alternative financing approach.”

Even when a deal is structured, asset-based lending can present some thorny issues.

“For a lender, valuation can be an issue, particularly for assets that are used in highly specialized industries or

market segments,” says Kaufold. “Contrast this with receivables-based financing, where the valuation is based

on the receivable itself (which has an explicitly stated value) and on the ability of the customer to pay it off

(which can often be determined using credit rating agencies).”

GE Commercial Finance’s Brasser acknowledges the challenges that asset-based lending can present, such asdetermining a market value for Work-in-Progress (“How much is a half-built widget worth?” he asks, rhetori-

cally), but he also adds that experienced finance professionals can find solutions to these and other situations.

They do this, in part, by gaining a thorough understanding of their clients.

“An asset-based lender that is doing the job properly will consider a wide range of metrics, expanding the

spectrum of borrowers that can qualify,” according to Brasser. “We do more than just valuing assets.” He

explains that asset-based lenders often tend to take a integrative approach, examining the entire manufacturing

process, noting the time-to-collection of receivables, conducting sales trend analyses and considering such

issues as the market for the borrower’s raw materials.

Compared to a cash-based financing organization, an asset-based lender assigns less weight to going concern,

competition, market share and business strategy-although these issues are considered-and spends more time

reviewing profit margins and determining whether the business can cover its interest expense and other debt

service. “The process isn’t focused entirely on the balance sheet,” says Brasser. “Lenders also look at meas-

ures that help to gauge the liquidity of a company.”

When Giants Fall — a Case Study

Consider, for example, the case of Callaway Golf Company, a leading Carlsbad, Calif.-based designer, manu-

facturer and marketer of golf equipment and accessories. Formed in 1982, Callaway had a string of successfulyears that was suddenly disrupted in 1998 when the company’s bottom line plunged from a $132.7 million

profit for the year ended Dec. 31, 1997, to a $26.5 million loss for the year ended Dec. 31, 1998.

According to documents filed with the SEC, the publicly held company’s financial setback was traced to a

number of factors, including increased competition and economic turmoil in some key markets, challenges that



18




are not unique to any particular industry. But the timing in this case was especially critical, since Callaway

was about to embark on an expansion program that would have a long-term impact on the company’s

prospects.

In November 1998, Callaway’s existing, unsecured lender began to get nervous given the recent deterioration

in the Company’s financial performance,” recalls Robert Yasuda, a GE Commercial Finance vice president

who worked on the case. “At the same time, Callaway was seeking additional financing by year-end for a new

venture.”

In the face of decreasing sales and margins at Callaway, GE Commercial Finance proposed the combination of

an asset-based revolver and accounts receivable securitization as the best way to accomplish the company’s

goal of a refinancing by December 31. At the time Yasuda says, GE’s Commercial Equipment Finance group

was already involved in arranging a separate $56 million off-balance sheet financing arrangement with

Callaway. Yasuda’s division (GE Commercial Finance) was soon brought in and before Callaway’s deadlinehad structured $75 million in financing, which was converted into a $200 million facility in the new year. The

larger financing included a $120 million revolving loan secured by inventory, machinery and equipment, real

estate and other assets. The funding helped the company to expand its operations even as it discarded non-

core ventures.

“It was a good investment, and we’re still involved,” observes Yasuda. “The company has since done very

well. GE Commercial Finance was able to step in and help when the borrower was going through a difficult

period, a time that commercial banks, with unsecured lines, hesitated to get involved.”

More Funds Mean More Reporting

Of course, a CFO may have to jump through some hoops to qualify for this kind of financing. Outlining some

steps, Brasser notes that an asset-based lender needs to feel comfortable with the inventory, equipment and

other numbers being reported by the borrower.

“One significant issue is the borrower’s physical inventory,” he says. “How often do they conduct a physical,

and how well does the count correspond to the records? If there is a large deficit, it could indicate weak inven-

tory controls, which could pose a problem.”

And while asset-based lenders may not place as much emphasis on financial ratios as commercial banks typi-cally do, it doesn’t mean they will ignore them either.

“If we see a period-to-period degradation in inventory turnover, we’ll ask for an explanation,” Brasser says. “It

could simply be part of the business’ regular cycle, but it could also indicate stale inventory, which could have

19






an impact on valuation. Borrowers know we’re keeping a close watch on their operations, but it’s worth it to

them.”

As Wharton’s Kaufold notes, asset-based lending may not be right for every company. But it can be a lifesaver

for the ones for which it works. “It’s a long-term relationship that depends on understanding clients’ business

cycles and working with them,” says Brasser. Asset-based lenders work with some of the best brands in the

world, some of which were healthy and then encountered difficulties. But they may also lend to bankrupt busi-

nesses on the basis of their assets held as debtors in possession. Asset-based lending can help companies

migrate from a distressed condition to a fiscally sound position. For the lender, it’s all part of the strategy of

acceptable risk.

Additional resources:

CFO magazine: May 1, 2001

Mining the Balance Sheet

www.cfo.com

Commercial Finance Association

www.cfa.com



20




Corporate Restructuring-A Possible Alternative to Chapter 11

The rapid expansion of a well-known transportation company ran into a roadblock when it was forced to write

off about $2.5 billion of $3 billion in acquisitions made under an overly optimistic growth plan. The company

considered filing for Chapter 11 bankruptcy but instead elected to first explore an alternative in the form of a

financial restructuring.

Even as more ailing businesses file for court protection through a reorganization or Chapter 11 bankruptcy,

(20,335 businesses filed for Chapter 11 through the first half of 2001 compared to 18,699 for the same period

in 2000, according to the American Bankruptcy Institute), an out-of-court restructuring may be an attractive

option, according to experts from GE Commercial Finance and from Wharton.

Indeed, in a recent dispatch from Dow Jones Newswires, Deutsche Bank chief global strategist Abraham

Gulkowitz noted that corporate restructuring is as crucial as political and economic policy actions to fostering

an economic recovery in the U.S.

“Over the past year, business pressures to restructure have already been the center of the economic storm,”

Gulkowitz said, according to the October 12 report. “Companies will streamline costs and also rationalize

product lists and rethink asset and capital structures.”

For a company with declining revenues and increasing expenses, restructuring may offer some advantages

over a Chapter 11 filing-such as less publicity and potentially lower professional fees, including advisory and

legal fees, according to Jim Hogan, a senior vice president, underwriting with GE Commercial Finance.

But while offering a qualified recommendation, Hulya Eraslan, a Wharton assistant professor of finance, cau-

tions that many restructurings fail, and may not even be an option in some cases.

Generally, a restructure involves the revision of financing terms, operating contracts and other issues, without

court involvement. The process typically falls into one of two categories: operational, which may involve the

redesign of processes or personnel deployment; or financial, which may focus on debt, lease agreements and

other fiscal concerns.

“The choice of a restructuring is not an arbitrary one,” explains Hogan. “Instead it’s determined by a closeexamination of the issues. Sometimes, a company may need to engage in both kinds of restructuring effort.”

On the surface, a company that is undertaking a restructuring may be perceived as healthier than one that files

for Chapter 11, observes Eraslan.

“Unfortunately, many people, including investors and suppliers, get skittish when they hear a company is fil-

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ing for Chapter 11,” she says. “This is because they often do not

differentiate between a Chapter 11 reorganization and a Chapter 7 liquidation.”

As a result, a Chapter 11 filing can affect a company’s cost of capital and may also have a negative impact on

the willingness of suppliers to do business with the enterprise. But Eraslan adds that a restructuring may also

hamstring a business’ access to financing.

“It may be easier to obtain new financing in bankruptcy, as opposed to obtaining it under a restructuring,” she

says. “For example, a company may have an existing negative covenant with a primary lender, an indenture

under which the borrower agrees not to pledge any of its assets if doing so would give the primary lender less

security.” She adds that under a Chapter 11 filing, such negative covenants may be voided, enabling the bor-

rower to seek Debtor-in-Possession and other types of financing.

When a company considers a restructuring, it should examine what it can offer to gain the confidence of financing institutions, suppliers and other interested parties.

“At a minimum, a company going through a restructuring should thoroughly examine its existing strategies

and develop a plan which truly addresses the reality of its current business situation. But many companies

remain in denial until it’s too late to take corrective action,” comments Stuart Armstrong, Managing Director

and head of GE Commercial Finance’s National Restructuring Group. “Among other issues, management

should consider whether the restructuring plan will be a revenue/price increase driven turnaround or a cost-

reduction strategy. Revenue and price increase turnaround plans are much more difficult to execute.”

He adds that tough decisions will have to be made in a variety of areas. “Nothing should be considered off

limits when a company is in a fight to survive,” he advises. “Cost reduction is typically a core strategy,

whether its headcount reduction, shuttering excess plant and distribution facilities, and, in the case of retailers,

they may need to consider their ability to exit any unfavorable long-term leases.”

Other approaches include converting debt to equity-although Armstrong admits this may be more easily

accomplished under Chapter 11-and unloading non-core businesses.

“Management and its advisors should also develop estimates of the liquidity that any new restructuring financ-

ing will provide,” he adds. “Will it enable the company to survive in the short term and allow it to execute its

long-term recovery strategy?”

He notes that one indicator, cash burn, considers earnings before interest, taxes, depreciation and amortization

(EBITDA), reduced by capital expenditures, and amortization and interest on debt. “Generally, a company

considering a restructuring should have access to enough liquidity to last through 12 months of cash burn,”

says Armstrong. “A company should never assume a quick turnaround.”



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Finally, some corporate soul-searching may also be in order.

“The board of directors needs to take a careful look at management,” advises Armstrong. “Is the team propos-ing new ideas, or just repackaging the same approaches that got the company into trouble in the first place?

Do key executives have turnaround experience, and are they willing to face the reality of the company’s situa-

tion? Businesses in trouble are often in denial, and delaying the recognition of their situation will only make it

more difficult to overcome their troubles.”

While a restructure may fit the bill for some firms, there are a number of indicators that can signal whether a

Chapter 11 filing might be appropriate, according to Eraslan. “For example, companies facing massive litiga-

tion-like asbestos manufacturers, and others where the potential pool of future litigants is unknown-may need

the protection of Chapter 11 to create a trust fund,” she says. And companies with large numbers of small

bondholders may have difficulties conducting negotiations outside of a Chapter 11 framework. “This is

because in an out-of-court restructuring the Trust Indenture Act requires the unanimous consent of all creditorswhose claims are in default. If some creditors hold out for more attractive terms, then the entire restructuring

may fail.”

Eraslan also questions the total amount of legal-related costs that a company can trim by pursuing a restructur-

ing, as opposed to a Chapter 11 filing.

“There is a general perception that a restructuring will incur less fees and other costs than those associated

with Chapter 11, but the significance of the difference is open to argument,” she comments. “For example,

while a number of studies indicate that direct costs associated with Chapter 11 average about five percent of

the filing company’s value, some studies suggest that the costs are ‘much lower’ for an out of court restructur-ing, although specific dollar figures were not presented.”

But she points out that any cost savings must be weighed against the benefits, in particular, the probability of

success. “If the success probability is low-and studies indicate that about half of the firms that enter into

Chapter 11 first try an out of court restructuring and fail-then the companies can avoid the additional costs of

an out of court attempt by filing Chapter 11 directly,” she says. “Of course there are indirect costs associated

with an out-of-court restructuring, including the potential for lost customers and suppliers; and the total costs

may vary by industry.”

Eraslan notes, though, that a restructuring may offer a significant advantage.

“Studies indicate that shareholders get larger concessions from creditors in restructurings,” she says. The

thinking is that the creditors may be willing to give up larger concessions in restructurings to avoid the costs

of Chapter 11. Under this interpretation, the incremental costs of bankruptcy decrease to about four-and-a-half

percent of the firm’s value.”

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Armstrong cites another advantage.

“A Chapter 11 filing can be time consuming, and the filing company may lose control of the process as thecourt assumes a great deal of authority,” he says. “While some situations may indeed call for a Chapter 11

strategy, it’s worthwhile to examine each case with an experienced advisory firm before taking any action. A

Chapter 11 filing can be time consuming and expensive.”

As analysts like Deutsche Bank’s Gulkowitz point out that pressures on businesses to restructure will continue

to build, specialists like Eraslan, Armstrong and Hogan note that the challenge will be to first lay the proper

groundwork, and then to execute the plans in a thoughtful, measured manner.



24




The Right Way - and Some Wrong Ways - to Make an Acquisition

Some mergers, like marriages, are made in heaven. The union of two companies augments revenues, boosts

profits, generates shareholder value - and wins applause on Wall Street. Other mergers - also like marriages -

are made in hell. Turf battles break out, management deadlock ensues, revenues fall, the stock plummets, and

inevitably a slew of shareholder lawsuits challenges the ill-matched combination. The hard part, of course, is

being able to predict ahead of time which scenario will play out after an acquisition.

The challenge in making an acquisition work - which determines whether the future will be heavenly or hellish

- is managing the process correctly. This involves paying close attention to factors ranging from setting clear-

sighted goals and knowing what to look for during due diligence to recognizing the circumstances in which it

makes sense to walk away. While there is no golden nostrum that suits all situations, experts at GECommercial Finance and the University of Pennsylvania’s Wharton School explain that focusing on a few

basic principles could greatly improve the chances of making a merger succeed.

Choosing a Target

Assuming that a company has decided to embark on an acquisition strategy, how should it identify a target?

That question can cover a range of possibilities from cutting-edge opportunities to distress situations and

everything in between.

In selecting a target, companies should consider whether the acquisition would let them extract value in three

ways. First, the takeover should make it possible to lower costs through economies of scale and better costmanagement. Second, the acquisition should be able increase the combined company’s market power by

spreading the stronger brand name over a wider product or service base. And third, the takeover should help

the acquiring company change the competitive game. Harbir Singh, a professor of management at Wharton,

explains that Cisco Systems has pursued the last strategy with considerable success. “Cisco recognized that it

could not be innovative in every technology, so it built its technological base through acquisitions,” he notes.

Cisco reportedly has acquired some 40 companies in six years.

From Due Diligence to Integration

Once a target has been identified and a deal has been initiated, the critical phase of due diligence begins. A

crucial objective at this stage is to spot potential deal-breakers, or issues that are so serious that the proposed

acquisition would have to be abandoned. According to Singh, one reason why many acquisitions flop - or fail

to deliver on the promises envisioned by their architects - is that “executives fall in love with the acquisition

and want it to work at any cost.” That mindset is often a recipe for disaster.

John Lanier, a Quality master black belt in the Access GE group of GE Commercial Finance, points out that

25






errors during the due diligence phase are rarely technical. In fact,

most people who manage takeovers for a living do a competent job of technical analysis. “The reason why the

prognosticated value fails to appear in many cases is that people fail to pay enough attention to cultural fac-tors,” Lanier says. “That is why many acquisitions flounder - because of the people side, the soft side. That is

the reason for failure in three out of five cases.”

GE’s discipline for managing acquisitions is rigorous in this respect. “We platoon a large cadre of due dili-

gence professionals, and we try to cover all bases,” Lanier says. “We consummate about two acquisitions a

week at GE, so acquisitions are a compelling part of our growth model.” As a result, GE has refined its acqui-

sition tactics over time and ensured that it looks at more than numbers when it takes over a target company.

What factors does GE examine when it acquires a company? Among them: The target company’s market posi-

tion; its products or services; the degree of customer satisfaction with these products/services; the uniqueness

of the product/service line; and potential threats to or weaknesses in the product/service line. “In short, welook at how viable the company is,” Lanier says. Since the goal is also to integrate the acquired company into

GE, a lot of time is devoted to examining how to ensure a smooth integration of cultures. This means paying

close attention to people issues. “If people are not united around a common vision, and they don’t understand

their individual roles, responsibilities, measurement systems and reward systems, the confusion that results can

be both demoralizing and inefficient,” Lanier notes.

In practice, this means that when GE targets a company for acquisition, it names an acquisition integration

manager whose full-time responsibility is to integrate both organizations. This executive acts as the liaison

between the acquired company and the business leader at GE who is responsible for the acquisition. So vital

does GE consider the integration manager’s function that the individual is identified well before an offer letter

is sent to the target company. This lets the integration manager become familiar with the target company, while

also ensuring that if an offer is made and accepted, GE can hit the ground running. For example, the integra-

tion manager can be prepared with a communications plan that announces the takeover to employees and

answer their questions. “We have learned over time that it is best to be proactive,” Lanier says.

Another non-trivial aspect of managing the human side of acquisitions is coping with executive egos. These

are generally dealt with during the negotiation process. Unless this is done, an acquisition can fall apart for as

seemingly trivial a matter as whose name is on a certain parking space. Such horror stories abound in

Corporate America.

Some Common Errors

Wharton’s Singh points out that one of the most common mistakes companies make in planning and executing

an acquisition is poor due diligence. Another common error is overestimating - and over-valuing - the potential

synergies that the combination will bring about. “When an acquisition is made in an auction-like atmosphere,

where several potential acquirers are bidding for the same target, it is easy to make this mistake,” Singh notes.



26




Among the examples he offers of a merger that is widely believed to have gone awry is the one between

Chrysler and Daimler-Benz. Although it was once hailed as the union of two world-class auto makers, the

Chrysler operation has been hemorrhaging cash, many former Chrysler executives have quit or been fired, andthe company has announced massive layoffs. “The company simply did not have a well-developed post-inte-

gration strategy,” Singh adds.

GE’s Lanier identifies several potential pitfalls. Among them:

1. Lack of a compelling strategic rationale.

This tends to happen if a company is caught up in a hot M&A market. Its leaders may begin to feel that

since they aren’t involved in a merger, they don’t measure up - and embark on a merger largely to gratify

their egos. They may end up buying a company that makes no sense at all. This happened during the 1970s

when “diversification” was the buzzword du jour. Some heavy manufacturing companies got into services

that had little or nothing to do with their core operations. A farm implement company, for example, enteredthe office furniture business -eventually with disastrous results. The first question to ask, in order to avoid

making this mistake, is: “Why am I doing this?”

2. Inadequate due diligence.

This means that some significant aspect of the business did not get disclosed or understood during the due

diligence phase.

3. Unrealistic expectations or excessive price.

The leveraged buyouts of the 1980s offer a good example of such acquisitions, especially in the retail sec-

tor. Several of these companies, which went private at high levels of debt, had to go through bankruptcybefore they could find viable operating models.

4. Failure to integrate expeditiously.

One reason why GE appoints a full-time manager to oversee integration each time it acquires a company is

to speed up the process. Depending on the size of the target company, the integration process could be as

short as a month, or as long as a couple of years. Still, it is important to prioritize things that are most

important - and to lay out milestones of who will do what by when. The point is to do this as rapidly as

possible, and with a sense of urgency and “without ever, ever, ever losing customer focus,” says Lanier.

“The customer couldn’t care less how long it’s taking you to integrate. What they want to know is if they

can rely on you as a vendor. Anything that threatens that relationship threatens your enterprise value.”

5. Lack of shared vision.

It is common for acquiring companies to have a different vision and philosophy than the companies they

have bought. This is often overlooked. “Assumption is the mother of all disaster,” says Lanier. When peo-

ple aren’t on the same page, it gets in the way of achieving common goals.

27






6. Conflicting corporate or national cultures.

Americans, for example, are regarded as aggressive, cut-to-the-chase kind of business people, and some

national cultures may regard such a style as being offensive. Every culture has its own mores, and it iseasy to offend people out of ignorance. On a corporate level, companies may have autocratic environments

or empowered environments. A company with an empowered environment will probably be more success-

ful buying one with an autocratic environment rather than the other way around.

7. Not investing adequate resources to consummate the transaction

Acquisitions don’t just happen. Enough resources must be provided to those trying to integrate the organi-

zations of two companies to do their jobs effectively. While this is more easily done in large organizations

than in small ones, it is a critical issue that must be addressed.

Some Ground Rules

Lanier offers some concluding rules of thumb for executives responsible for overseeing acquisitions.

“Integration is a process, not an event - in much the same way as personal development is a journey, not a des-

tination,” he says. “Integration begins with due diligence, though many companies don’t do it that way. Some

organizations wait to buy a company before they address how to integrate it into their existing operations. That

is an error. It is crucial to anticipate, and to get integration managers involved as early as possible. The choice

of the integration manager is critical, because that person must have the trust and confidence of both the

acquirer and acquiree. Roles and responsibilities must be established early. Get the buy-in of the CEOs of both

acquirer and acquiree organizations. If you have to make tough decisions - such as letting go some senior

managers - make them early and handle them professionally. Don’t let them fester. And finally, recognize that

the soft, people issues will always be more challenging than the hard, operational ones.”



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The Corporate Conundrum-Is It Better To Buy An Asset Or To Lease It?

Today’s CFOs face a unique set of challenges-meeting long-term capital growth needs against the backdrop of

a weakened economy in an environment where rapid technological developments can render capital invest-

ments obsolete within a few years. As financial institutions continue to tighten lending policies and as corpo-

rate boards ponder ways to get the best return on assets (ROA), some businesses have slashed their capital

spending plans. They have done so despite the danger that this may cripple their ability to take advantage of

otherwise valuable investment opportunities.

Other companies, however, are exploring alternatives to traditional financing and are finding a variety of ways

to meet their capital needs. In today’s tight-money environment, CFOs need to examine purchase-financing

decisions more closely than ever before, according to experts from Wharton and GE Commercial EquipmentFinancing. They say that cost-of-capital considerations, covenants, flexibility and improving liquidity/cash

flows have now joined traditional ROA benchmarks as key decision drivers.

A commercial printer on the West Coast took out a large loan to acquire pre-press equipment. But rapid tech-

nological advances in the industry meant that the costly assets were soon obsolete. After only three years the

remaining balance on the loan far exceeded the value of the equipment. Later when the firm made another

equipment acquisition, it chose a three-year lease that afforded a purchase-or-walk-away option that shifted the

burden of obsolescence to the lessor.

Lessees vary widely from small, one-person operations to Fortune 100 corporations. The types of equipment

being leased are just as diverse, according to the Equipment Leasing Association (ELA), an Arlington, VA.-

based trade organization. Transactions range from a few thousand dollars worth of equipment (such as fax

machines) to multi-million-dollar co-generation facilities, telecommunications systems, medical equipment

(including CAT scanners and MRI imaging), office systems, computers, commercial airliners and transporta-

tion fleets. In 2001 the ELA estimates that $280 billion worth of equipment was leased.

“There’s no blanket solution to a business’s capital acquisition needs,” says William C. Tyson, a Wharton asso-

ciate professor of Legal Studies, Accounting, Management and Law. “It’s important to consider each transac-

tion and its issues, both as a purchaser/owner and as a lessee.”

He notes, for example, that the lease payments on an asset are generally tax deductible, while the depreciationexpense deductions associated with a purchase-traditionally used to offset taxable income-may only be a limit-

ed benefit if a purchaser is posting a loss for tax purposes.

However, he adds, if an equipment lease is structured with an option to purchase, the IRS may recharacterize it

as a sale instead of a lease (as it should be if there is deemed to be a “bargain purchase option”).

29






“Similar care should be exercised with a sale-leaseback,” cautions

Tyson. “If it’s done properly the transaction will be honored, but if it’s not, the IRS may recharactertize it as a

loan.”

Choose Your Partners Carefully

When a company considers an equipment lease, the careful selection of a financial institution as a partner is a

critical first step, according to David Beckstead, Territory Sales Manager (Anaheim, CA) for GE Commercial

Equipment Financing.

“A qualified financial institution can help to avoid the pitfalls of an improperly structured equipment lease

agreement,” notes Beckstead. “Choosing the wrong partner could jeopardize the strategic advantages offered

by leasing.”

Beckstead notes that those advantages include an enhanced cash flow since monthly payments are typically

lower than a straight loan. The cash made available from the lower payments can then be applied elsewhere in

the business. “Additionally, options like an early buyout (EBO) give a company the ability to modify its asset-

exit strategy if circumstances change,” he says. “An equipment lease is all about tailoring solutions to fit a

company’s needs.”

Beckstead notes that a lease may also enhance such crucial ratios as ROA since the revenue generated from

leased assets is a component of ROA’s numerator, but the underlying assets, which do not appear on the bal-

ance sheet, are not factored into the computation of the ratio’s denominator. And, as noted earlier, “Equipment

leasing may also allow companies to acquire equipment while maintaining compliance with bank covenants.

And it’s a good option for businesses concerned about acquiring PCs and other assets that can be quickly ren-

dered obsolete because of advances in technology.”

Tax considerations also play a role, especially when a company can use a depreciation deduction. As an exam-

ple, Beckstead points out that IRS rules generally treat non-realty assets as being placed in service in the mid-

dle of the initial year, resulting in one-half of the accelerated depreciation deductions that would be allowed if

the assets were in service for the entire year.

The Right Solution

Equipment leasing is an attractive solution, but Victor Defeo, a Wharton lecturer in the department of Accounting, sounds a note of caution.

“CFOs should explore all the alternatives,” he says. “For example, heavy construction and certain other classes

of machinery and equipment may have useful lives that are long enough to justify financing an outright pur-

chase, instead of a lease arrangement. And because of the potential for such issues as long-term appreciation, a



30




corporation may also be better off owning some assets like real property, instead of leasing them.”

Defeo adds that, depending on how the agreement is structured, the monetary difference between an outrightpurchase and a lease may not be significant. “As an owner, a company has a lot more freedom of action with

regard to an asset,” he notes. “As a lessee, your company’s rights may be constrained.”

Therefore, being aware of a lease’s terms and conditions, including possible transfer of ownership and flexibil-

ity to terminate, is a prudent part of the review of the lease option. Also keep in mind, adds Defeo, that if the

lease is classified as an operating lease, the lessee would not be required to report either the leased asset or the

lease liability.”

Loan Considerations

Despite tightened lending standards, the potential wide range of government-backed loan programs means thatmany companies looking for funds stand a good chance of finding a lender match according to John Coad, a

National Sales Manager with GE Small Business Finance. These choices are even offered by some of the same

financial institutions that offer leasing options.

“Such loan programs as the 7A (under which the federal government’s Small Business Administration guaran-

tees up to $1 million of a loan that does not exceed $2 million) and a 504 (a hybrid made up of two simultane-

ous loans consisting of a first mortgage with no mandated dollar limit issued by a bank or other provider and a

second-position loan debenture of up to $1.3 million issued by the Small Business Administration (SBA) via a

local Certified Development Co.), may offer greater comfort to lenders and give them additional incentive to

consider a loan application in a positive light,” observes Coad. “Unfortunately, some businesses still have mis-conceptions about the time and effort required to put an SBA loan together. Long ago it may have been cum-

bersome, but the SBA has really streamlined the process in recent years.”

He adds that borrowers pursuing an SBA loan solution will have a better, streamlined experience when dealing

with lenders who carry the distinction of “Preferred” SBA lenders. For the borrower, this designation can

mean much faster loan closings and documentation requirements that are similar to that of a routine (non

SBA) conventional loan.

Coad points out the advantages and limitations of each approach, noting that an SBA loan may offer a lower

down payment, lower monthly payments and, under the 504 program, may feature attractive long-term fixed

rates. Conventional loans, he says, often have balloon payments, which can upset cash flow planning, whileSBA loans are fully amortized and eliminate a sudden spike in cash outflow.

Loans involving the SBA, however, have eligibility requirements and other restrictions that may be stiffer than

those of other programs. Citing the 504 program, Coad notes that it is generally limited to funding the acquisi-

tion of fixed assets, such as owner-occupied real estate or machinery and equipment.

31






“In contrast, the 7A program has few restrictions on how the capital may be used,” he says. “The 7A also gen-

erally offers a longer amortization, which translates to lower payments and a lower down payment-usually10% on real estate and up to 100% financing on equipment. The 7A loans are also fully amortizing, and pre-

payment penalties are limited.”

Buy vs. Lease

As cash flow continues to assume greater importance, the question of “buy versus lease” is becoming more

critical, says Defeo. “While the decision will depend on a mix of issues, including tax considerations, a CFO

should also review the capital structure of his or her company, looking carefully at such areas as cost of capital

and company strategy,” he notes. “And the same planning that a CFO will use to determine the best lease-or-

buy strategy may also be leveraged to help persuade a financial institution to enter into a more favorable leas-ing or loan arrangement with the firm.”

Whatever the “best” financing choice is for an individual business, there are a varied number of lease and loan

options available, as well as financial institutions, ready to provide them.

Articles should not be considered legal interpretations; neither party assumes liability for loss or damage as a

result of reliance on this material. Appropriate legal, accounting or other expert advice should always be

sought before making personal or financial decisions.



“GE”, General Electric”, GE Capital”, the GE Logo, and various other marks used in this

publication are registered trademarks and trade names of The General Electric Company

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