What is a 'Leaseback'
A leaseback is an arrangement where the seller of an asset leases back the same asset from the purchaser. In a leaseback arrangement, the specifics of the arrangement are made immediately after the sale of the asset, with the amount of the payments and the time period specified. Essentially, the seller of the asset becomes the lessee and the purchaser becomes the lessor in this arrangement.
BREAKING DOWN 'Leaseback'In order for a company to grow, it must have capital. Companies raise capital in a variety of ways, with the two most popular ways being taking on debt and giving up equity. 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, also referred to as a sale leaseback, is neither debt or 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 pawn shop transaction. The company goes to the pawn shop 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.
Most Common Users
The most common users of sale leaseback arrangements are builders or companies with high 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 receive 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.