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Financing and ensuring a prospering business
Written by: Simona Plischkeová & Jiří Hrstka (www.penize.cz)
Photo by: Petr Poliak

Financing via leasing is gaining popularity here, and local entrepreneurs are discovering that they can thus acquire just about anything. But in order to minimize the risks that may threaten one's business, suitable insurance products must be entailed.

KAREL ŠIKOVNÝ is just starting out in business. He has an interesting business plan and he's closely acquainted with a prospering firm that has promised to buy all his production. Šikovný also needs to finance the start-up of his business, but none of the banks he's approached want to give him what he needs. No wonder. Start-ups always have trouble getting money, despite banks' proclamations of their increasing willingness to provide loans. So he began to consider leasing - something that, until recently, he saw as a means for wealthy businessmen to acquire expensive cars. He learned that he could also get computers, a production line, and even a factory building through leasing. But acquiring equipment isn't all a beginning entrepreneur should be interested in. His business can be jeopardized by many other things as well. What if his main client doesn't pay his bills? Or, on the other hand, what if the client wants to be sure that an interruption of Šikovný's operations won't impact him? There are more such dangers, and Šikovný should be ready for them. So he decided to find out what his options are.

Ivo Ščuka           Photo: Petr Poliak

Loan or leasing?
At the word "leasing", most people automatically think of cars, but some may already be aware that large transport vehicles (such as ČSA's planes) can also be acquired through leasing. The leasing of machines and equipment hasn't yet taken root in the Czech Republic - according to Association of Leasing Companies data, it accounted for only 20% of the value of all leasing deals in 2003. However, since this acquisition method is very common in western European countries, one can expect growth here to come. Compared with bank loans, easier access is certainly one advantage of leasing. Leasing companies have little interest in your company's economic results - you don't even have to properly document its financial history. All you have to do is pay for your machines or facilities regularly and on time. For start-ups, leasing can be the only way to buy on credit. Leasing is also better in terms of accounting - only the down payment must be written off, while the leasing payments are accounted for as rent, which is included directly under costs.
" Besides the possibility of earlier write-offs, another advantage of financing through leasing is that approval of a given business case is usually much faster and more flexible than when loans are used for financing," says David Prostý of Česká spořitelna Leasing. He claims that when machines or equipment are financed through leasing, the milder requirements for securing the deal imposed by the leasing company that owns the property to be leased constitute a substantial advantage - conversely, when banks provide loans they usually require many security instruments for better risk coverage. "Probably not all leasing company clients know that with selected commodities one can deduct 10% of the market entry price from the income tax base - this is the so-called reinvestment deduction defined in Paragraph 3 of 34 of Law No. 586/92 Coll.," Prostý points out.
However, bank loans have one important advantage over leasing: you can do whatever you like with the equipment, and even sell it (provided of course that the bank doesn't have a lien on it). With leasing you have to agree with the company to transfer the leasing arrangement (but the leasing company doesn't always have to consent) or pay off all the installments at once, after which you can sell it. Another substantial disadvantage of leasing is the required insurance on the equipment - with a bank loan it's up to you alone to decide on insurance.

More options
Šikovný started slowly in business, and at first acquired just a single van via financial leasing. As time passed, he needed more vehicles, but he didn't want to spend time arranging regular maintenance, repairs, and insurance, or employ someone to take care of all that. So he switched from financial leasing to operational leasing, which sees to all car fleet management. "When the van has a defect the leasing company provides the entrepreneur with another one according to the agreement. In the event of accident the entrepreneur pays only the deductible, and the leasing company takes care of the rest - repair, or junking and replacement," explains Ivo Ščuka, bussiness director of Business Lease, one of the biggest operational leasing provider in CR.
The vans wear out, of course, so Šikovný didn't want to own them. Operational leasing met this need, because after the end of the lease the vehicles aren't the entrepreneur's property - or responsibility. Also, the leasing company ensures the replacement of the leased item when it's worn out and no longer fit for use. "Operational leasing offers many customized offers for clients, and of course this affects the price," summarizes Martin Mitterwald, LeasePlan's sales and marketing director. Operational leasing can also be a solution for companies that already have their car fleet. "Within our service Sale & Lease Back we are able to buy out clients car fleet, taking into account the state of the cars, and transfer it to the leasing contract. With financial sources acquired through this transaction the company can cover other business expenses," Ščuka explains.
Besides movables, land and buildings can also be acquired through leasing. This is quite common around the world. For example, according to Association of Leasing Companies information, around 20% of all real estate is acquired through leasing in the EU. In the Czech Republic double taxation constitutes a certain barrier, because when the real estate is transferred, first the leasing company pays the tax at the beginning of the lease, and then the client pays it again at the end of the lease. But despite this disadvantage, real estate worth more than CZK 9 billion was leased last year. "The advantage of leasing for financing lies primarily in the strong linkage to the building. Throughout the entire duration of the contract the leasing company owns the property, which allows financing with less capital and at ordinary interest costs over a longer term," says Alois Lanegger, managing director at Raiffeisen Real Estate Leasing. He sees an indisputable advantage in the great number of financing variants in both financial and operational leasing. Other specialized services can be arranged - from construction management to managing the entire development process.

Ivan Špirakus   Photo: Vladimír Weiss

Adequate "life" insurance for a firm
"Just" having sufficient money isn't enough to ensure a well functioning business. Entrepreneurs shouldn't ignore insurance, because there are many risks that can threaten their firms' existence. Compared with their counterparts in more developed economies, Czech entrepreneurs carry only a little insurance coverage, but one can expect that coverage for domestic firms will increase, not just because of the sense of greater responsibility toward the firms that give them a living, but also due to greater pressures exerted by business partners.
For example, a customer who uses an entrepreneur's product as his final product will probably require confirmation of valid liability insurance against damages caused by the entrepreneur's goods. He also wants to be sure there is insurance to cover interruption of the operation. Of what value to a final producer is it to have a supplier who is unable to meet his commitments and deliver a part on time? Documentation of high-quality property insurance can be required by a leasing company or a bank at which the entrepreneur puts up the firm as collateral, or a mortgage bank with whose funds he built his firm.
This procedure is far from unusual. Furthermore, attachment creditors pay greater attention to their clients' insurance. "Recently some banks have been asking us to inform them if clients cancel their insurance or stop making regular payments, or if something else arises that could lead to limitations on possible settlements," says Michael Neuwirth, Allianz's director of the department of property and liability insurance of citizens and entrepreneurs. There are many policies covering various business risks, so how does one know the ins and outs?

Limits to control
High-quality insurance coverage for a company must include property insurance. A policy can cover buildings as well as movables like production and operational equipment - from machinery with complex electronics through office decorations and supplies, to items in safekeeping for repairs. Property insurance covers "standard risks" - fires, floods, earthquakes, thefts and robberies, and many others. Electronics, including company software or machinery, can be supplementarily insured against risks caused by the human factor, and in such a case the insured risks are broadened to include operation errors, clumsiness, inexpert handling, or inexperience. You can also insure against the cost of renewing data or data themselves, but in no case their value.
If an event that is covered has already occurred, such as a flood, just settlements from property insurance will not ensure the firm's continuous operation. A client can't be expected to wait months for delivery without seeking out a new partner. "So it's also possible to insure against costs caused by an event, including, for example, expenditures on ensuring operations somewhere else - i.e., moving production lines or renting other buildings," says Neuwirth. "Similarly, one can also insure against interruption of operations as a result of an event. This insurance covers lost profits and fixed costs that must be paid even though the operation isn't running, e.g., monthly power bills, wages, and leasing payments," he adds. The insurer pays until the firm gets back to its original market position.
Entrepreneurs should be aware that collision insurance usually doesn't cover damages to cargo. So transport insurance is also a useful "business product". It covers either a specific load, so-called shipment insurance, or a specific vehicle, i.e., cargo insurance. Also covered are natural disasters, theft, and robbery. The insurance is arranged for the real value of the transported goods, from the place of shipment to the destination, including all transfers or storage along the insured route.

Michael Neuwirth   Photo: Petr Poliak

Responsible business practices
Among the most important insurance coverages that every entrepreneur should have is damage liability insurance. Such insurance covers cases when an entrepreneur, in connection with his business activities, causes damage to a third party and is obligated to pay compensation. "Due to the absence of claims, this insurance is very inexpensive," says Ivan Špirakus, the executive director of the brokerage firm Portfolio Alfa and vice chair of the board of the Chamber of Insurance Brokers. Such a policy also covers damages caused by defective products or faulty workmanship, as well as damages incurred in connection with ownership and operation of buildings. If a roof tile falls from an entrepreneur's facilities on someone's head, or if a client breaks a leg on an icy sidewalk in front of the firm, this policy ensures a settlement.
However, Špirakus points out that there's a catch to such insurance. "Damage liability insurance covers damages to health and property, as well as subsequent financial damages following therefrom (e.g., lost profits), but in most cases it doesn't cover financial damages incurred by a partner-client through the manufacture of a product using a defective part from a supplier," he explains. The client then bears the costs of recalling the products, their destruction, etc. However, the "hammer" eventually comes down on the supplier, as the client will demand compensation for these costs, but the policy doesn't cover this.
When it's necessary to recall defective products some insurers' portfolios include coverage of risks for such actions. Such policies cover the costs of, for instance, media warnings about defective products, information on how to return products, costs of transporting defective goods, their destruction or repair, and possible eventual return to consumers. Some insurers broaden their damage liability insurance to cover these risks. (For more financial damage examples)
" It always depends on the type of insurance, the covered subject and its value, on which the premium level is based, and, of course, the risks that the policy covers," Neuwirth says, explaining the factors affecting "entrepreneurial policy" prices. In general, a firm should buy insurance protection covering from 1% to 3% of its sales, but this isn't always the best practice, as one must always consider the specific area of business and the risks connected therewith.

Solving insolvency Markéta Stržínková   Photo: Petr Poliak Not only natural disasters can inflict great damage on companies. Major customers who default on their commitments can also wreak havoc. "However, firms can insure themselves against clients' insolvency or unwillingness to pay bills," notes Markéta Stržínková, the director of credit insurer Atradius, adding that roughly 70% of such covered events are due "only" to unwillingness to pay for goods. To minimize losses, such policies cover clients' entire portfolios of receivables, not just individual deals, and the solvency of each client is thoroughly evaluated. According to client solvency and the amount of receivables, the insurer sets a so-called credit limit. Its value should correspond to the greatest possible sum the customer can owe to the insured party at any given moment. Evaluating a customer's solvency also serves the client. If an insurer doesn't want to insure the commitments of a specific customer, it signals that doing business with such a customer need not turn out well. "By checking individual customers, we help our clients select and develop their customer portfolios, enabling them to evaluate the risk of default in advance," claims Stržínková.