Valuation of a Lease Company
by Paul R. Doyle, CPA, Doyle, Hull & Gregory, CPAs, Inc., Pasadena, California. Ph. 1.626.577.2925
There are many reasons, other than the desire to sell a business, for wanting to know the value of a leasing company. Financial statements, which rely on proper accounting principles, may not reflect the true performance or worth of a company. Many lessors feel that the only way to measure how they have done is to prepare a valuation each year on a consistent basis. Other lessors use the valuation as an additional tool to help convince investors or lenders of the true worth of the company. Valuations can also be utilized to update buy/sell agreements. If desired, these valuations can be compiled by a CPA to increase their credibility. The only way to determine the true value is to obtain bids from potential buyers. However, if a valuation calculation is performed in a consistent manner from year to year it can provide some very useful information and hopefully will be an approximation of the market value. The valuation calculation that I recommend is as follows (see also attached table 1); Discount value of payment stream - This is the primary ingredient in the calculation because it accounts for all of the active leases. The process consists of discounting the remaining payments and residual value (net of any security deposit) for each lease back to today using a reasonable discount factor. The present value calculation is the complicated part; it can be done with a sophisticated calculator like the HP 12C or a computer program. For example, a lease with 19 remaining base monthly payments of $350, a residual of $4,000 and security deposit of $400 has a gross remaining value of $10,250 ((19 x $350) + $4,000 - 400). The discounted value using a 12% factor would be $9,069. This indicates that if someone wanted to achieve a 12% return on their investment they would be willing to pay $9,069 for the payments and residual remaining in that lease. The discount factor is obviously subjective; some lessors would feel 15% is appropriate and some would feel 11% is appropriate. If the portfolio is being valued for sale, the actual yield that the buyer wants to achieve should be used; however, if the purpose of the valuation is to measure performance, the discount rate should be consistent from year to year unless there are wide swings in the cost of borrowing. Another subjective area in this calculation is the residual value. This should be what the lessor believes will be received at lease termination regardless of what the lease contract specifies. Notes payable - leases - This is the bank payoff for all active leases as of the valuation date. Excess of other assets over other liabilities - This accounts for the items in the lessor's balance sheet that were not separately dealt with above. The assumption is that these assets and liabilities are equal to book value. Thus, all non-leased assets should be added and all liabilities, excluding notes payable - leases and security deposits, should be subtracted to obtain a net value for all other assets and liabilities. Estimated bad debt and repossession losses - This is an estimate of the potential losses to be incurred on the portfolio. Estimated costs to run-off the portfolio - This is based on the total remaining payments for all leases times a factor that represents the monthly administrative cost. This may not be a component if the portfolio is being sold because the buyer may be able to absorb the leases without increasing costs. This component would definitely be a factor if the portfolio was to be run off. In any event, inclusion of this component is made for general valuation purposes because it is a cost that would be incurred to achieve the discount value described above. Goodwill - This is a final catch-all and relates primarily to the renewal value of the lease portfolio. Essentially, it can be viewed as what would a lessor pay in terms of a commission fee for the renewal. If the answer is $300 per unit, the lessor must then realistically assess the renewal potential. This is a subjective area and is dependent upon the purpose of the valuation. For example, if the portfolio is being sold, the factors to consider would include expected sales force retention, employment contracts, non-compete clauses and whether operations were going to be moved to a new location. Additionally, a buyer of a portfolio would want to review the following items before preparing the valuation described above: * Verify that the insurance tracking system is in place and that all lessees currently have insurance. * Review the credit policy and a sample of actual files for compliance with the policy. Review the accounts receivable aging report for delinquencies and try to verify its accuracy. * Review the residual values to be sure they are realistic. Any downward adjustments should be reflected in the discount value calculation. * Review the seller's financial statements and discuss with management the policies in effect on items that may not be apparent, like loaner cars. * Have a competent attorney draft or review the purchase/sale documents. Sellers should also be aware that there may be a large tax liability if the portfolio is sold. This will be a function of the selling price, prior operations, depreciation elections, the amount of loss and investment tax credit (ITC) carryforwards available and whether any ITC has to be recaptured (in 1989 and later this would only apply to equipment leases). SAMPLE VALUATION SUMMARY SCHLEDULE
Discounted cash flow of active leases @ x % 10,000,000
Notes payable - lease financing, active leases 9,100,000
Net discounted value 900,000
Excess of other assets over other liabilities at cost 60,000
Estimated bad debt and repossession losses (50,000)
Estimated general and administrative expenses to run off the portfolio at $x/unit/month (190,000)
Goodwill 250,000
--Value 970,000
Please note that the above numbers are for illustration purposes only and do not represent an actual leasing company.
Updated 2 March 1999
