Business Trust Fund
A leaseback is an agreement where an asset's seller leases back the asset from the purchaser. In a leaseback arrangement, the details of the arrangement, such as the lease payments and lease duration, are made immediately after the sale of the asset. Essentially, the seller of the asset becomes the lessee and the purchaser becomes the lessor.
How Leasebacks Work
Most often, a company needs capital to grow. Companies acquire capital by either debt or equity financing or both. The debt must be paid back and goes on the company balance sheet as a debt. Equity does not need to be paid back, but it comes at the cost of ownership. A leaseback allows this to happen.
Types of Leasebacks
The most common users of sale-leaseback arrangements are builders or companies with high-cost fixed assets. A leaseback arrangement is useful when a company needs to use the cash invested in an asset for other investments, but the asset is still needed in order to operate.
Leaseback deals can also provide the seller with additional tax deductions. The lessor benefits in that it receives a guaranteed lease with stable payments for a specified period of time.
Although sale-leasebacks have a different accounting treatment than debt, they are generally not considered to be financing and therefore stay off the balance sheet. This is why some analysts add capitalized leases to long-term debt when trying to get a big picture of the company's total debt obligation.
Examples of Leasebacks
A leaseback also referred to as a sale-leaseback, is neither debt nor equity. In fact, a sale-leaseback is more like a hybrid debt product. The company does not increase its debt load but gains access to capital through the sale of assets.
This is much like the corporate version of a pawnshop transaction. The company goes to the pawnshop and in exchange for a valuable asset, receives a certain amount of cash. The only difference is that there is no expectation for the company to buy back the asset.
For example, assume company A has a need for additional capital to pay employees and contractors but can't access the debt markets due to poor credit. The company sells equipment to an insurance company with the understanding that the equipment is to be immediately leased backed to the seller.
As long as the amount charged for this service by the insurance company does not exceed the rate of interest on high-interest loans, the sale-leaseback is the better option.