Lessor vs Lessee
Capital Lease Agreement
Sale and Leaseback Definition
The sale and leaseback definition is a transaction in which a company sells its property to another company and then leases that property. The company that sells the asset becomes the lessee, and the company that purchases the asset becomes the lessor. In this type of transaction, the lessor is typically an insurance company, a finance company, a leasing company, a limited partnership, or an institutional investor.
The property sale is done with the understanding that the seller will immediately leaseback the property from the buyer. The details of the lease agreement are arranged for a specific period of time and a set payment rate. Depending on the type of lease arrangement, whether it’s an operating lease or a capital lease, the lessee may or may not record the leased property on its balance sheet.
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Why would a company sell an asset and then lease it? The company may want to free up cash tied up in the property. Also, the company may arrange for a capital lease, in which case it can keep the asset and the liability off of its balance sheet. Finally, since the sale-and-leaseback arrangement is a type of loan, the company may want to enter into this type of deal if the lease payments are lower than the interest payments it would have had to pay if it had borrowed money to finance the purchase of the asset.
The primary advantage of the sale and leaseback arrangement is that the company selling and then leasing the asset is essentially releasing the cash tied up in that asset prior to selling it. It also continues to benefit from the usage of the asset. If the lease is a capital lease, the company can keep the value of the property off of its balance sheet. Depending on the terms, the arrangement may be cheaper than financing the purchase of the property with a bank loan.
Sale and Leaseback Example
Let’s look at a sale and leaseback example. Imagine a company owns an asset but is having difficulty freeing up cash for current liabilities and short-term debt payments. The company has poor credit, and a bank loan would be very expensive.
The company could instead choose to sell one of its long-term assets to an insurance company. Immediately, they should arrange to lease that asset back for a specific period of time. If the insurance agrees to lease the asset for a rate less than the interest rate the bank wanted to charge the company for a loan, then the sale-and-leaseback arrangement with the insurance company would be the superior alternative.
This way the company is relieved of its cash shortage. It uses the proceeds from the sale to payoff short-term debts and liabilities in order to continue operations. It is also able to continue to benefit from the utilization of its asset. If you’re looking to sell your company in the near future, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.
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