What is Leaseback?
Leaseback is a financial transaction in which the company sells its asset and then takes the same asset on lease from the purchaser, which implies that the seller becomes the lessee, and the purchaser becomes the lessor. This type of sale and leaseback transaction is done on mutual understanding of both the party and all the terms and conditions are predefined in the agreement.
Why Companies do Sale and Leaseback Transaction?
- Lessee or Seller Perspective: The seller (lesseeLesseeA Lessee, also called a Tenant, is an individual (or entity) who rents the land or property (generally immovable) from a lessor (property owner) under a legal lease agreement. ) wants to free his cash involved in the property or assets so that he can use this cash for other purposes but still wants to use such assets or property.
- The Lessor or Buyer Perspective: Generally, purchasers (lessorLessorA lessor is an individual who legally owns the asset granted on a lease (rented for a long tenure) to the lessee who pays a single lump sum amount or regular payments for using that asset.) who are involved in these types of transactions are finance companies, leasing company or institutional investorsInstitutional InvestorsInstitutional investors are entities that pool money from a variety of investors and individuals to create a large sum that is then handed to investment managers who invest it in a variety of assets, shares, and securities. Banks, NBFCs, mutual funds, pension funds, and hedge funds are all examples.; they are looking for a good investment that will give them a good amount of return on their investment.
Key Elements of Leaseback Transaction
The following are key elements of leaseback.
- Need of Capital: When a company has the needs of capital for further investment, then they will go for leaseback transactions.
- Excess Capital and Looking for Good Investments: Purchaser or lessors who are entering this transaction only want to make a good return on their investment.
- Strong Tenant: Investors who buy and give on lease want a relatively stronger tenant who can meet their obligations, and their investment will be in safe hands. Similarly, a strong tenant can sell their assets at a higher rate and make the transaction profitable for him.
- Long Term Lease: In Sale & leaseback transactions, generally lease terms are happening for 10 years or more than 10 years so that it will be beneficial for lessor and lessee both. Lessee will be benefited by using the assets without any interruption, and lessor will get the lease rent for a longer period without having any risk.
- Triple Net Lease: This is one of the conditions which generally lessor wants to include in the sale & leaseback agreement. In a triple net leaseTriple Net LeaseTriple Net Lease is a type of lease agreement in which the lessee (tenant) agrees to also pay for other property-related expenses such as insurance of the building, maintenance of the building, property taxes in addition to the rent., lessee takes responsibility for incurring operating expenses, maintenance costs, insurance costs, and any other cost just like the owner of the assets, and the investor will only enjoy the rental income, and he does not have to bother about all these things.
- Interest on Loan is High: If the rate of interest loan is higher than the lease rental expenses, then also companies use this type of arrangement to reduce the expenses.
Example of Sale and Leaseback Transaction
Now we will understand sale & leaseback transaction with the help of one practical example:
Some years ago airline companies were using this type of arrangement the reason for this arrangement was since the cost of the plane, as well as the operating cost of an airline company, is very high and they have the pressure of reducing the ticket price for capturing the market and for competition in the market.
Therefore what they are doing is they bought a plane and sale it to the leasing company and immediately take back on lease. By that arrangement, airline companies will get their cash-free and spread the cost of the plane into the over the life of plane through lease rental and utilize the cash generated from the sale of a plane to meet the operational cost and reduce the liability.
- The seller can avoid the capital cost associated with assets, and still, he can use those assets.
- It can save the time and administrative cost associated with the assets because all will be taken care of by the purchaser or lessor.
- Reduce tax liability because lease paymentsLease PaymentsLease payments are the payments where the lessee under the lease agreement has to pay monthly fixed rental for using the asset to the lessor. The ownership of such an asset is generally taken back by the owner after the lease term expiration. are tax-deductible expenses and reduce the overall income of an organization.
- Improve the balance sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.; the company can avoid debt by this transaction and increase the current assets in the form of cash, which is generated through the sale of assets.
- Improving working capital which can be invested in other things or use this for day to day operating expenses;
- In case the property has a longer useful life, then it will have become a costly affair for the seller because total lease payment will be more than the cost of the assets over the year.
- The company will not be able to take the benefit of depreciation since the property is not owned by them.
- Seller will not get the appreciation benefit if the value of assets sold is an increase in the future like land and building.
- The sale of assets will reduce the company valuation in the market, which can be used for taking the loan in the future.
- Loss of control over assets, and there is a case that at the time of renewal of the agreement, lease rent will increase.
Sale & Leaseback transaction is only an arrangement for reducing the capital expenditureThe Capital ExpenditureCapex or Capital Expenditure is the expense of the company's total purchases of assets during a given period determined by adding the net increase in factory, property, equipment, and depreciation expense during a fiscal year. without compromising the availability of assets. Those organization which has a shortage of cash balance and not able to meet their day to day operating expenses or companies which are initial phase and focusing on business expansion are using this type of transaction so that their cash balance could not be blocked into capital assets and use these cash into other things and on the other side investor are entering into these arrangement because they want a good return on their investment and in such type of arrangement they are secured because of the long lease term, and they are also relieved from all responsibility by mentioning triple net lease clause in the agreement.
This has been a guide to what is leaseback and its meaning. Here we discuss the example of sale and leaseback transaction along with its key elements. We also discuss the advantages and disadvantages. You can learn more about financing from the following articles –