A capital idea

The hard-pressed boss of an engineering firm is on the phone to his bank. ‘Hello,’ he says to the bank manager. ‘Henry Butchers are having an auction of secondhand machine tools tomorrow and in the catalogue there’s this 25-tonne press brake. It’s 10 year

Imagine the reaction from most banks or industrial finance houses: ‘It’s a what? How old? The auction’s tomorrow? What about security? Sorry, don’t think so, old chap.’

This is a typical experience for cash-strapped engineering firm. Except in this case the press brake was bought with an instant loan. The happy bidder at the auction in south Wales this month is one of a growing band of engineering firms which are turning to a radical US method of financing capital equipment purchases through operating leases.

Introduced into the UK by Henry Butcher, Europe’s biggest auctioneer and valuer of capital plant and machinery, the operating lease is essentially a sale and lease back arrangement in which a factory sells its machinery to Henry Butcher and rents it back over a fixed cycle.

The cash released is used to finance the initial purchase of the machinery or to fund further acquisitions and expansion.

The scheme is operated by Henry Butcher Industrial Finance, a joint venture with The Asset Management Corporation, a buyout from US-based McDonnell Douglas Bank.

It works because Henry Butcher sets the secondhand market price of capital equipment. It buys and sells everything from printing equipment and plastics machinery to machine tools and cranes. So, with only the machines as security, the company can be confident of recouping its money by selling them if the customer goes bust. ‘We buy plant [from clients] at the same price we would get if we were selling it,’ says Trevor Crome, a partner in Henry Butcher. ‘We add a percentage for profit and for doing the deal.’

For a cash-starved engineering company it means a cheaper deal than a bank can offer and no deposit or extra security is needed. An operating lease is an operational cost and so is off balance sheet, having minimal impact on a firm’s accounts, and does not affect its other borrowings.

Providing a firm’s credit is good, the cash can be raised over the phone within hours. ‘We try to turn applications round in one or two hours, because people ring us quite close to the auction date,’ says Robert Murray, a director of Asset Management.

In the case of that press brake, the client saw an HBIF advert in the Henry Butcher auction catalogue and rang the financier. HBIF rang Henry Butcher to get a value for the machine and then checked out the client’s credit. Within hours, a £5,000 loan was agreed.

Although operating leases are a primary source of industrial finance in the US and used widely for ‘big ticket’ items such as aeroplanes, the concept has been slow to catch on in the UK. ‘Small firms don’t like leasing items such as machine tools. They want to own them,’ says Crome.

But operating leases come into their own when factories change hands, as Reg Cole and his colleagues at Segmatic Engineering in Swindon have discovered.

With a £112,000 HBIF operating lease, Segmatic and its nine staff have gone from a standing start to a turnover likely to hit £450,000 in just two and a half years.

The story began in 1995 when defence contractor Chemring group decided to close its subsidiary Kembrey Engineering, a supplier of aircraft and automotive wiring connectors in Swindon. Henry Butcher was asked to auction off the 400 or so machines and all the employees faced redundancy by the end of January 1996.

Kembrey’s works manager Reg Cole, production controller Chris Cook, colleague Steve Phillips and four setters decided to buy some of the machines and set up their own firm, Segmatic. Although the local bank was encouraging it set very tough terms for a loan.

The group had a business plan, commitments from Kembrey customers of work for a year, and had negotiated a good price with Chemring for the 20 or so machines they wanted. But the bank would only lend them 70% of the £112,000 they needed, leaving them to find a £34,000 deposit. It also wanted their houses and property as a security. ‘We had no real savings… We would have had to borrow money to pay a deposit to get the loan,’ says Cole.

Happily, Kembrey’s boss knew Henry Butcher and asked if it could help the buyout. And so Segmatic became one of the first clients of Henry Butcher Industrial Finance.

HBIF agreed to loan Cole and his colleagues the £112,000 with no strings. The machines were bought and then leased back from HBIF.

Cole, now Segmatic sales director, explains how the operating lease works. ‘For the first three years we pay back the loan. In the second three years we pay a reduced amount to cover the costs and charges and in the third three years we pay a peppercorn rent. Then we can decide whether to buy the machines or continue renting them.