Ready to fly? Why finance can give your startup wings20 September 2017 Category : Entrepreneurship
Gaining traction for a new venture from day one is every entrepreneur’s dream. You want to appear dependable, credible and financially astute. But creating a good impression and appearing established depends as much on having effective, up-to-date equipment as it does on sound financial judgement.
One way to ease the pressure on startup budgets and cash flow is by keeping hold of capital and choosing finance, or leasing, for that equipment. Leasing can kick-start a business by giving a degree of flexibility and control, allowing entrepreneurs more room for manoeuvre when new opportunities, or unexpected expenses, arise.
Asset-based finance – what is it?
Leasing or asset finance is a financial mechanism by which a company enjoys exclusive and unrestricted use of a particular asset vital to its revenue stream – in return for fixed monthly payments over an agreed timeframe. For startups in the UAE, almost anything is available under lease, including ICT hardware and software, data storage solutions, telecoms, gym equipment, office furniture, coffee machines and even UAE trade licenses.
For startups in the UAE, almost anything is available under lease, including ICT hardware and software, data storage solutions, telecoms, gym equipment, office furniture, coffee machines and even UAE trade licenses.
Why finance is the entrepreneur’s best friend
Organisations opt for asset finance rather than purchase for a variety of reasons, but underpinning every single decision is a universal understanding that revenues and profits are earned through an asset’s usage, not its ownership. That’s essential for startups because they can draw on the income those assets generate in order to meet the lease payments over the course of the asset’s lifetime, keeping hold of precious capital reserves for future investment in business growth and new personnel.
Doing things quickly makes a better impression
Key to gaining early traction for a startup is the ability to fire on all cylinders from day one, and that means having all the right tools at your disposal. If the infrastructure is in place, the ability to build a new venture is maximised. Gaining credibility and trust among clients and customers is enhanced by those crucial first impressions and if you have failed to equip yourself adequately for your new venture, you might not be taken seriously.
But acquiring the right kit need not be expensive: by choosing a lease over outright ownership, entrepreneurs protect themselves from the often crippling depreciation and rapid obsolescence inherent in purchasing equipment and can enjoy much faster approval rates than for bank credit because leases are collateralised by the asset itself. This makes assets available even to new ventures with a limited track record or credit history, for which traditional bank finance might not be an option.
Who’s doing it and why?
Across the globe, from aircraft to medical imaging equipment, construction plant to IT hardware and software, organisations finance asset acquisition through a variety of leasing structures, making it the smart choice for businesses large or small. In Europe, research by Oxford Economics on behalf of Leaseurope estimates that over 50% of European SMEs used some form of leasing in 2014, up from 40% in 2010, and the Equipment Leasing & Finance Foundation reports that 78% of companies in the US used finance when acquiring equipment in 2015, up from 72% reported in its 2012 survey.
The UAE, despite the lack of reliable, up-to-date statistics, has historically been among the top four leasing markets in the Middle East and North Africa region (MENA), with annual leasing volumes for the country estimated to be in excess of USD 1bn in 2010. The top four regional leasing markets (UAE, Iran, Kuwait and KSA) combine to account for a total of USD 6.2bn, according to a report by the International Finance Corporation of the World Bank.
But what are the benefits driving this growth in SME take-up?
1. Healthy cash flow: In an analysis of 101 startup failure post-mortems conducted by CB Insights in 2014, 29% failed due to lack of cash. But new ventures can mitigate this risk by better managing their working capital over the course of an asset’s lifetime. In short, it’s essential to hold on to as much cash as possible. Even if an enterprise is profitable on paper, if slow receipts cause negative net cash flow (when payments exceed receipts), with no liquidity there won’t be anything left to meet your outgoings and it can easily fail.
Choosing finance over purchase means that a startup can keep as much of its cash as possible. Outsourced finance and bank credit, as many SMEs know all too well, is a finite resource and if you don’t have to access it for equipment purchase, cash reserves and liquidity can remain high.
Leasing helps cash flow because, as you’re not buying the asset outright and can typically finance up to 100% of the price, there is no initial cash outlay and no down payment required. Structured leases tailored, for example, to seasonal fluctuations can help manage the budgeting cycle and meet cash flow needs to cover for predicted periods of negative net cash flow and, because of the certainty of pre-fixed monthly repayments, cash flow forecasting is enhanced.
It’s worth noting that companies that run out of cash don’t always do so because of underfunding. According to the Chartered Institute of Management Accountants, effective cash flow forecasting is essential to monitoring net cash flow so that negative periods can be covered by operating capital. ‘Managing cash flow,’ it says, ‘is vital to both the survival of a business and to its long-term well-being.’
Effective cash flow forecasting is essential to monitoring net cash flow so that periods of negative net cash flow can be covered by operating capital.
2. Better quality equipment and more flexibility: According to research by the European Investment Fund, (EIF), the spread of payments often means that firms are more able and willing to lease assets of much higher quality than they would have purchased with cash. Coupled with the flexibility to upgrade assets regularly and in line with technological developments, this keeps entrepreneurs competitive by using the very latest, most efficient equipment available.
A new IT system, for example, if purchased outright with a bank loan, will likely become obsolete long before you’ve finished servicing that debt, but the ability to upgrade your hardware and software under a lease or an Infrastructure-as-a-Service (IaaS) arrangement means you’ll spend less time on mundane, time-consuming tasks as your outdated IT grows old and creaks, and more time talking to customers.
The lease of low-tech equipment is popular too. Office furniture, for example, accounts for more than 10% of total SME leasing in Europe, according to the EIF, allowing businesses to update regularly, keeping their offices looking fresh, sharp and efficient. This sustains a company’s ability to create a good impression and underlines the importance they place on that impression. Furthermore, as with high-tech assets, the lessee can choose from a variety of contracts, giving them the option to cancel before maturity, to renew for additional periods, or replace with newer equipment under a new contract.
3. Intangible assets included: Leasing is not limited to tangible assets: you can also spread the payment of certain intangibles, such as trade licenses. For example, Ajman Free Zone in the UAE, currently the only authority offering flexible payments for a trade license, offers a choice of two, three or 12 instalments. Spreading the cost of a basic general trade license in Ajman FZ over 12 months incurs a modest mark-up of about 11%, but if you choose to locate elsewhere, company setup specialists across the UAE offer packages to help spread at least part of the license costs over 11 months as a component of their service fee. You just need a UAE chequebook in order to qualify.
4. Positive debt/equity ratio and credit rating: When companies use capital or debt to finance purchases, it has a negative impact on their debt/equity ratio, making additional funding, if needed, more expensive. But because lease contracts are inherently collateralised by the asset, there is no need to provide collateral for the lease and so future lines of credit remain unaffected, allowing your venture the chance to obtain further finance to fund growth and expansion.
Because lease contracts are inherently collateralised by the asset, there is no need to provide collateral for the lease and so future lines of credit remain unaffected.
5. Tax efficiency: In practice, corporation tax is only levied on oil and gas companies and foreign bank branches in the UAE. The head of the IMF repeated her recommendation that Gulf states place a greater emphasis on corporation tax back in February 2016, and it was discussed in the UAE Ministry of Finance Annual Report 2014. Nothing concrete has yet been proposed but it’s worth bearing in mind for the years ahead because, if you’re not basing yourself in one of the many free zones, which guarantee long periods free from tax, operating leases allow lessees to treat monthly lease payments as a business expense, thus allowing them to shield against any tax liability on income.
Looking into leasing
The benefits of leasing are manifold: it can allow your startup to establish itself quickly while maintaining liquidity and increasing its chances of survival; it improves cash flow, offers operational flexibility and increases the ability to grow.
With that in mind, even if you can ‘afford’ not to lease, why would you?
Setting up your own business has never been easier. Virtuzone takes care of it all so you can focus on what matters – building your business. For more information about company formation in the UAE mainland or free zones, please call us on +971 4 457 8200, send an email to email@example.com, or click here.