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TECHNOLOGY REPORT: Bleeding Edge Solutions and the Power of Analytics Strategies for keeping up with technology

Gary Tannyan

May/June 2014 • volume 2 • issue 3 | www.canadianequipmentfinance.com

Accounting for the Purchase and Sale of Lease Portfolios The Next Generation: Transition and Succession Planning PM40050803


contents May/June 2014 Volume 2 Number 3 Publisher and Editor-in-Chief Steve Lloyd steve@canadianequipmentfinance.com Editor Karen Treml karen@canadianequipmentfinance.com Creative Direction / Production Jennifer O’Neill jennifer@canadianequipmentfinance.com

ELFA REPORT: Looking at the next four months – 31.4 per cent of executives responding to the MCIEFI say they believe business conditions will improve, down from 37 per cent in April, while 68.6 per cent believe business conditions will remain the same – up from 60 per cent in April. No one believes business conditions will worsen, down from 2.9 per cent the previous month; 34.3 per cent believe demand for leases and loans to fund capital expenditures (capex) will increase, down from 37 per cent in April, and 65.7 per cent believe demand will ‘remain the same’ during the same four-month time period, up from 60 per cent the previous month. »4

Photographer Gary Tannyan Advertising Sales Mark Henry mark@canadianequipmentfinance.com Brent White brent@canadianequipmentfinance.com Chantal Goudreau chantal@canadianequipmentfinance.com For subscription, circulation and change of address information, contact

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Publications Mail Agreement No. 40050803 Return undeliverable Canadian addresses to:

FEATURES The Technology Report Technology is ever-evolving and with some planning, holistic approaches can add budget flexibility while managing tomorrow’s needs. »10

Sector report:

Circulation Department 302-137 Main Street North Markham ON L3P 1Y2 t: 905.201.6600 • f: 905.201.6601 info@canadianequipmentfinance.com www.canadianequipmentfinance.com Subscriptions available for $40.00 year or $60.00 two years. 2014 Lloydmedia Inc. All rights reserved. The contents of this publication may not be reproduced by any means, in whole or in part, without the prior written consent of the publisher. Printed in Canada. Reprint permission requests to use materials published in Canadian Equipment Finance should be directed to the publisher. Also Publishers of Payments Business www.paymentsbusiness.ca Canadian Treasurer www.canadiantreasurer.com Contact Management www.contactmanagement.ca

Direct Marketing www.dmn.ca Financial operations www.financialoperations.ca Made possible with the support of the Ontario Media Development Corporation Ontario Interactive Digital Media Tax Credit

The Road to Technology Transformation Are today’s companies ready to meet the expectations of the younger generations in terms of the technology they use? »26

Accounting for the Purchase and Sale of Lease Portfolios The directors and officers of leasing companies need to recognize and internalize the need for knowledgeable, conservative, and well-documented management. »21

The Next Generation: Transition and Succession Planning

NEWS: A round up of news shows some continued acquisitions and investments. »7

your Business: Underperforming employees have an impact on the morale of the team. But spotting a bad apple can be tough. »17

EVENTS:

A properly thought out transition/ succession plan is often the difference between future success and failure. The challenge is one of how to approach the subject. »24

Find out where to go and what to see in 2014. »29

Observations: An Appraiser’s Tale.

With email limits, how do you get an appraisal report with 940 images from here to there? »30

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ELFA Report

Industry Confidence Remains at Two-Year High The May 2014 overall MCI-EFI is 65.4, relatively unchanged from the 65.1 last month, says the Equipment Leasing & Finance Foundation’s (ELFA) ‘Monthly Confidence Index for the Equipment Finance Industry’, which has peaked at the highest index level in two years for the third consecutive month. Looking at the next four months – 31.4 per cent of executives responding say they believe business conditions will improve, down from 37 per cent in April, while 68.6 per cent of respondents believe business conditions will remain the same – up from 60 per cent in April. No one believes business conditions will worsen, down from 2.9 per cent the previous month; 34.3 per cent believe demand for leases and loans to fund capital expenditures (capex) will increase, down from 37 per cent in April, and 65.7 per cent believe demand will ‘remain the same’ during the same four-month time period, up from 60 per cent the previous month. No one believes demand will decline, down from 2.9 per cent who believed so in April; 28.6 per cent of executives expect more access to capital to fund equipment acquisitions over the next four months, unchanged from April, while 71.4 per cent of survey respondents indicate they expect the ‘same’ access to capital to fund business, and no one expects ‘less’ access to capital, also both unchanged from the previous month.

Increase in Wiring Forty per cent reported they expect to hire more employees over the next four months, an increase from 37 per cent in April, 51.4 per cent expect no change in headcount over the next four months, down from 60 per cent last month, and 8.6 per cent expect fewer employees, up from 2.9 per cent who expected fewer employees in April. Almost three per cent (2.9) of the leadership evaluates the current U.S. economy as ‘excellent’, 91.4 per cent of 4

the leadership evaluates the current U.S. economy as ‘fair’, and 5.7 per cent rate it as ‘poor’, all unchanged from April. Thirty-seven per cent of the survey respondents believe that U.S. economic conditions will get ‘better’ over the next six months, an increase from 34.3 per cent who believed so in April; 62.9 per cent of survey respondents indicate they believe the U.S. economy will ‘stay the same’ over the next six months, unchanged from April. No one believes economic conditions in the U.S. will worsen over the next six months, a decrease from 2.9 per cent who believed so last month.

Business Development Remains Flat In May, 45.7 per cent of respondents indicated they believe their company will increase spending on business development activities during the next six months, an increase from 40 per cent in April, while 54.3 per cent believe there will be ‘no change’ in business development spending, a decrease from 60 per cent last month. No one believes there will be a decrease in spending, unchanged from last month. When asked about the outlook for the future, MCI survey respondent, Valerie Hayes Jester, president of Brandywine Capital Associates, Inc., says, “We have experienced a transaction flow that appears to be returning to a more normal state after the winter slowdown. Companies seem to be getting back on track and ordering equipment that should have been delivered in the first quarter. I am still concerned with the longer term effects of the many changes in our healthcare system as well as still undetermined tax policies that have great impact on small businesses.”

ELFA Introduces Guest Lecture Program The Equipment Leasing and Finance Association (ELFA) has created a Guest Lecture Program to increase awareness

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

of equipment leasing and finance and attract new talent to the industry. The free 30-minute PowerPoint presentation designed by industry experts is available for use at colleges, universities, and financing/banking institutions and is customizable, allowing you to share your personal experience. Download your copy at www.elfaonline.org/resources/ Index.cfm?fa=glp.

Speaking Proposals Due July 14 ELFA is now accepting speaking proposals for its 53rd Annual Convention, Oct. 19 to 21 in San Diego, CA. If you would like to lead a discussion on one of the important issues of the day, submit your proposal by July 14. All proposals will be reviewed by a committee of industry peers. Learn more www.elfaonline.org/events/?fa=call.

Video Highlights Benefits of Equipment Finance What makes America go? What makes America grow? At businesses nationwide, it’s access to equipment, according to the ELFA video ‘How Equipment Finance Equips Business for Success’. ELFA encourages you to watch the video, feature it on your website, and share it with your business contacts and social media channels to help spread the word about the benefits of equipment finance. Learn more at www. equipmentfinanceadvantage.org/value/.

Digital Toolkit Serves as Primer on Equipment Finance How can businesses make the best possible equipment financing decisions? What does a lessee need to know before entering an equipment financing agreement? ELFA’s Equipment Finance Advantage Digital Toolkit, an easyto-read, 12-page digital brochure for end users, answers these and many other questions about acquiring equipment. View the toolkit and find


ELFA Report tips for sharing it with others at www. equipmentfinanceadvantage.org/toolkit/.

Infographic Explores ‘The Road To Equipment Finance’ Infographics have exploded in popularity because they offer a quick and engaging way to convey complex information. The Equipment Leasing and Finance Association’s ‘Road to Equipment

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Finance’ infographic offers a quick and engaging snapshot of how equipment financing equips businesses for success. ELFA encourages you to share the infographic far and wide. Learn more at www.equipmentfinanceadvantage.org/ infographic/.

Michael Tobak named 2014 recipient of ELFA’s ‘Edward A. Groobert Award For Legal Excellence’ The Equipment Leasing and Finance Association (ELFA) has awarded Michael Tobak, senior vice-president and general counsel at GE Healthcare Financial Services, the ‘Edward A. Groobert Award for Legal Excellence’ in recognition of his significant contributions to the equipment leasing and finance industry and the association’s legal committee. Tobak has been an active member of ELFA for over a decade. He served on the association’s legal committee from 2009

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

to 2011. In 2009, he chaired the legal committee’s subcommittee on financial services at the height of the Dodd-Frank rulemaking activities, and continues to serve in this role. He oversees and helps direct ELFA’s response to various federal agency rules impacting the financial services industry in general, and the equipment finance business in particular. Mike has also assisted ELFA in conducting an aggressive state government relations program, providing legal expertise in drafting amendments to various legislative proposals, and engaged in direct negotiations together with association staff on behalf of the industry to inform state officials of the association’s position on various legislative matters of concern to ELFA members. Mike has made numerous presentations at the annual ‘ELFA Legal Forum’ and has authored articles in association publications.


News

Coast Capital and Travelers Financial Combine Equipment Finance Businesses Coast Capital Equipment Finance Ltd. (CCEF), a subsidiary of Coast Capital Savings has acquired the assets of the prime equipment and vehicle finance business of the Travelers Financial Corporation (TFC). Those assets are now part of the Coast Capital Group of Companies. The consolidated equipment finance business of the Coast Capital Group of Companies will be carried out under CCEF and the newly formed Travelers Finance Ltd. and Travelers Leasing Ltd. The combination will help strengthen offerings, diversify origination channels, and add new technology for faster service to customers, says the company. Operations will remain business-as-usual with no significant changes for the customers, staff, or leadership of each respective company. “By joining forces we are drawing on each organization’s natural strengths to create something truly special,” says Tracy Redies, president and CEO of Coast Capital Savings. “It is good for us as an organization, good for our customers, and certainly good for the marketplace as we have industry leading expertise and the ability to go out with superior offerings.” TFC is one of the largest independent finance and leasing companies in Canada, offering a wide range of assets-based financing solutions to commercial and industrial sectors. Headquartered in Burnaby BC, they also have offices in Alberta, Saskatchewan, Manitoba, and Ontario. Jim Case, CEO of Travelers Financial Corporation, says that the transaction is an exciting next step for the business. “We have always focused on what we can do to better serve our customers,” says Case. “This is another way to ensure that we are continuing to bring the best in expertise and pricing to them. We are happy to be part of the Coast Capital Group of Companies and look forward to building on our shared success.”

Hitachi Capital Canada Corp. Purchases CLE Hitachi Capital Canada Corp., a 100 per cent owned subsidiary of Hitachi Capital America Corp., has purchased CLE Canadian Leasing Enterprise Ltd. Hitachi. CLE has been a business partner of Hitachi in Canada since 2012. The acquisition of CLE strengthens Hitachi’s Canadian business base while improving its ability to grow financing activity in Canada. CLE will add assets of $198.4 million and annual originations of $129.6 million to Hitachi Capital Canada. “We are pleased to have completed the transaction as planned. The acquisition of CLE expands our footprint in Canada, which we view as an attractive operating environment and we have the utmost confidence in our new partners’ ability to expand Hitachi’s commercial financing capabilities in Canada” says Bill Besgen, president and CEO of Hitachi Capital Canada. The boards of both companies have approved the transaction and completion of the aquisition is expected within the next 45 days.

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To send press announcements, please direct them to Karen Treml, karen@canadianequipmentfinance.com

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News

Revenues Flat For Air Transport Services Group Air Transport Services Group, Inc., a provider of medium wide-body aircraft leasing, and air cargo transportation and related services, reported consolidated financial first-quarter results. Revenues were $143.6 million, flat with a year ago. Increases in revenues from aircraft

leasing and other business activities offset lower revenues from airline operations. Earnings from continuing operations of $6.5 million, or $0.10 per share, were lower than earnings of $8.5 million, or $0.13 per share a year ago. A $4.1 million increase in depreciation

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CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

and amortization expense stemming from the addition of more modern aircraft to ATSG’s fleet, offset decreases in other operating expenses. Adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization, also adjusted for the effect of derivative transactions) was $38.8 million, up four per cent from $37.3 million in the prior-year quarter. Adjusted EBITDA is a non-GAAP financial measure, defined and reconciled to comparable GAAP results in separate tables at the end of this release. ATSG executed a favourable amendment to its primary credit agreement which extends the term of the agreement until May 6, 2019, reduces interest rate pricing, adds a $50 million accordion feature, and improves its ability to execute stock repurchases and pay dividends to shareholders. Separately, ATSG added dry-leases for two Boeing 767-200 freighters to Cargojet, a Canadian airline, for terms of up to three years beginning in the second and third quarters this year. These aircraft are in addition to the two 767-200 freighters Cargojet currently leases from CAM. It also added dry-leases for two Boeing 767300 freighters to Amerijet, a Florida based airline, under six-year terms beginning in the third quarter this year. Amerijet currently leases three 767-200 freighters from CAM. Joe Hete, president and chief executive officer of ATSG, says, “This new business with two long-standing ATSG customers demonstrates their confidence in the value of mid-size freighters as vital components of efficient regional air-cargo networks, and in our bundled services offerings, which facilitate rapid implementation and scale efficiencies. These dry lease deployments evidence the strengthening demand for mid-size lift that we spoke of last quarter, and bolster our confidence that we can deliver at or above the upper range of our EBITDA guidance for 2014, based on improving performance, particularly in the second half of the year.”


News

GE Capital Equipment Finance Launches Global Financing Program for Polycom GE Capital Equipment Finance business has developed a financing program for commercial buyers of collaboration solutions developed by Polycom, Inc., a provider of secure and flexible video, voice, and content management solutions. “We are committed to meeting our customers’ total business needs by providing high-quality and cost-effective solutions,” says Walt Boileau, vice-president and corporate treasurer of Polycom. “This new program gives our customers another means to invest in business-critical collaboration technology that can help them overcome the barriers of location, time, and culture to compete more effectively.” “By closely aligning today’s rapidly changing business requirements with customers’ financing needs, manufacturers of all types can drive product sales,” says Jim Kelly, managing director of GE Capital’s Vendor Finance business. “Financing allows companies to conserve cash while procuring critical technologies.”

Element Sees Strong Organic Growth Element Financial Corporation, a North American equipment finance company, first-quarter financial results included record originations of $1.1 billion contributing to a 27 per cent increase in the company’s total earning assets to $3.8 billion, versus $3 billion in the previous quarter. After tax adjusted operating income increased by 37 per cent to $20.7 million, versus $15 million in the preceding period. “Element produced strong organic growth in the first quarter to set us on course to exceed our 2014 origination target of $3.86 billion,” says Steven Hudson, chairman and CEO of Element. “I am particularly pleased with the strong demand for new equipment that we are seeing coming out of the U.S. market as businesses replace aging equipment stocks and acquire increased capacity across a wide variety of transportation assets from railcars, to highway trucks, to helicopters.”

canadianequipmentfinance.com | May/June 2014 | CANADIAN EQUIPMENT FINANCE

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Gary Tannyan

Bleeding Edge with Budget Flexibility

By Andy Theophylactou

any of our customers, from small business owners to large enterprise executives, come to us with a preconceived notion of the IT purchase they want to make based on what they’ve always done in the past. They might say something like, “Our servers are old and outdated and we’re looking to replace them within a budget of about $100,000. What can you do for us?” On the surface, there’s nothing wrong with this question. It’s a common approach to a common problem – the customer needs hardware and here’s what he can spend on it.

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A holistic approach to IT acquisitions can help you have your cake and eat it too.

Considering Emerging Trends The challenge with this approach is that it really doesn’t solve the core technological and financial needs of our clients. Sure, our team can put together a hardware solution that will secure a client’s datacentre storage, but with the rapid technological advances we experience in this day and age, there are other things to be considered. For example, what about issues such as encryption, security, data management, remote access, and converged infrastructure? These are all areas that affect the operational and technological efficiency of a business and they will not

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

be addressed just by upgrading to a new cluster of servers. Emerging trends such as employees bringing and using their own devices at the workplace (BYOD) and the massive adoption of cloud computing add new levels of complexity to this challenge every day. These are all questions and considerations that speak to the tech realities of our time, and they are the questions we ask our clients so that we can better understand the breadth and depth of their technological and financial needs. The reality is that business and IT leaders have a lot more to keep them up at night than just aging servers – and they’re


TECHNOLOGY often counting dollars in tight budgets more than they’re counting sheep.

Tailoring with a Holistic Approach So, to ‘walk the talk,’ the first thing we do when a client comes to us with a specific hardware need is help them take a step back to look at the big picture and consider a new strategy. In other words, we say, “Let’s not look at this as a couple of servers. As you’re looking at scaling out your portfolio, let’s look at doing it based on what your challenges have been in the past and what you will need in the future.” When done right, this can help the client start thinking about a holistic tailor-made solution that also includes financing to help keep the business growing into the future. Businesses looking to upgrade their IT infrastructure need to understand the advantages of this holistic approach to IT. There are many new financing and technology solutions in the market that range from a utility model to internal and external cloud solutions. Each has their advantages, but the right choice will give a business the technology it needs in the long term with an effective payment solution that ties to its budgetary and cash flow requirements.

Adding Budget Flexibility What we see over and over again is that this holistic approach works. Consider the case of BlueSun, a fastgrowing Canadian technology company that recently came to Dell with a big business challenge. BlueSun provides software solutions for the financial services industry. It needed to reduce datacentre hosting costs with technology that would allow it to scale and build its infrastructure to match its future growth. After careful consideration of all of its technological and budgetary needs, BlueSun decided to deploy a comprehensive solution that included a virtualized server, networking, and storage in a single location, along with financing for the entire purchase. This combined or ‘holistic’ solution included hardware and implementation assistance, giving them a complete and integrated technology and financing solution. The key for BlueSun wasn’t just that it

“Businesses looking to upgrade their IT infrastructure need to understand the advantages of this holistic approach to IT …” saved money by moving from a managed services environment to a new datacentre. The rate it received on leasing and other financial terms, tailored to the business and its new IT infrastructure, gave its management more budget flexibility. BlueSun CEO Simon Tomlinson told us the lease rate the company received worked better for them than anything they could have gotten from a bank, adding that the company is able to put more of its money toward product development instead of infrastructure now, so it can concentrate more on the software solutions it provides.

Managing Tomorrow’s Needs Frankly, that’s the biggest benefit I see for customers who are savvy enough to build financing into their technology acquisitions. Not only are they saving money in the near-term, but they’re building their IT infrastructure needs into the core of their business strategy, leading to more strategic and carefully considered growth plans for the future. Effective IT management doesn’t just happen as a knee-jerk reaction to sudden changes in needs. IT teams almost never have enough hands on deck to manage the current load of work, much less the demands coming around the bend; so senior management has to be focused on the future and manage tomorrow’s needs even before they become known. Whether it’s a custom refresh cycle that ensures the company always has ‘bleeding-edge’ technology, or a lease rate that frees up capital for other business needs, the key is to have a custom solution for the long-term business plan. The best way to build this long-term custom solution is through a cooperative approach that allows technology and financial advisors to work together. While the CIO is focused on technical needs, the CFO is engaged in making

sure the payment solution works for the entire business, not just for one department’s budget. This collaborative approach also extends to our client interaction. For example, our financing team looks for the client’s guidance based on how the company wants to pay for its solution so it can have more control over its long-term budget, while our technical advisors work on building a complete IT solution.

Having the Cake – Eating It Too We all know access to capital is one of the key building blocks for businesses of all sizes looking to scale and grow their footprint in the marketplace. A complete technology and financing solution that incorporates hardware rotations, security, software, and services catered to specific business needs with payments that fit within the budget is not just a smart move financially, it’s a core piece of a comprehensive strategic business plan. In its June 2012 IDC white paper, commissioned by Dell, titled ‘IT Buyer Perceptions, Strategies, and Requirements: Results of IDC’s 2012 IT Leasing and Financing Survey,’ International Data Corp. (IDC) says “IT organizations that lease and finance their equipment, software, and services are an evolved group that has arguably taken the first steps to consider ways to reduce the risk of technology obsolescence and align spending to return on investment before the rest of the industry.” In the end, a holistic approach to IT acquisition through the technology financing options available in today’s marketplace really is the best way for businesses of all sizes to have their cake and eat it too. Andy Theophylactou, Country Manager, Dell Financial Services Canada. Andy Theophylactou has more than 17 years of experience at Dell helping consumer and business clients acquire the technology they need to grow, thrive, and reach their full potential. He can be reached at Andrew_ Theophylactou@Dell.com

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Technology

Keeping Up with Technology Companies fear migrations will take too long, be over budget, disrupt their business, and fail to deliver the expected benefits. This need not be the case. By Roxana Safranek

echnology is advancing rapidly, leaving many equipment finance companies struggling to define the impacts and where their business fits. Since the real business impact of technology comes from how it’s deployed and used by the people both inside and outside of the organization, business leaders need to have a good understanding of their organization to determine how to move forward. Not every equipment finance company needs to undergo an immediate or comprehensive technology transformation; sometimes the only change required may be around business processes or a new approach to customer service.

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How Much, How Fast Historically, technology decisions have been centered on efficiency – how can it help to get the job done better and faster? Currently however, the demands placed on technology also include – developing new products, branching out into new markets, and being reactive to evolving market and customer demands. Technology is what enables businesses to be innovative, to accelerate, and to gain a competitive advantage. So when businesses are summing up their technology needs they should also be thinking about how much, how fast, and in what direction they want their business to grow, as well as, what technologies and systems will best support these strategic goals, how to get the most out of their data, and how to best assure that the infrastructure is reliable and secure. The answers to these questions will help define a technology strategy. 12

Developing the Strategy A common mistake companies make when developing a technology strategy is expecting their IT managers to fully understand the strategic vision for the business. The technology group has to interpret the requirements that emerge as a result of the corporate/business level strategic vision, so it is critical for these groups to work closely together. The first step in developing a good technology strategy is by understanding how your company creates value for your customers and the consistent challenges your organization faces. When evaluating this information, it is important to consider what is needed to generate topline revenue, improve gross margins, and improve the customer experience. If you intend to grow your business, it’s important to invest in a scalable infrastructure. Taking this approach will prevent buying one-off stop-gap solutions, in favour of technology that comes with the flexibility and scalability your business needs to be successful. The next step is to develop a clear technology strategy that encompasses your business goals. Too often companies jump from one system or application to another without fully realizing the benefits of their technology. Without a defined strategy, companies make poor buying decisions, adopt ineffective tools, and often experience a high level of frustration. The businesses that excel typically establish a technology strategy that helps them gain a competitive advantage through cost savings, realize process improvements, achieve faster time to market, and improve quality and service levels.

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

Technology encompasses both a cost of doing business and an opportunity to do more, and there needs to be a dynamic balance between efficiency and innovation. There are many reasons why a company may elect to upgrade their software and/or hardware platforms. Some of the more common reasons are additional functionality, competitive advantages, a vendor phasing out support, new industry regulations, etc. Whatever the reason behind the migration, there are three major areas of focus that will drive the success of the project – defining a project scope, developing a project plan, and assigning a dedicated project manager.

Determining Project Scope The first thing a company considering a migration project should focus on is putting together a project scope. By definition, a project scope involves determining and documenting specific deliverables, tasks, costs, and deadlines. It’s important when developing the project scope that all the stakeholders for the project have input, understand the scope, and agree upon how the project’s goals will be met. The project scope establishes the boundaries of the project, the responsibilities for each team member, and sets up procedures for how completed work will be verified and approved. During the project, it helps the project team remain focused and on task. The project scope also provides the team with guidelines for making decisions about scope changes during the project. When documenting a project’s scope,


TECHNOLOGY the project stakeholders should be as specific as possible in order to avoid scope creep, a situation in which parts of a project end up requiring more work, time, or effort than accounted for. It’s not uncommon for a system migration project to change along the way, so the better the project has been ‘scoped’ at the beginning, the better the project team will be able to manage any changes that may be needed. According to the Project Management Institute, 64 per cent of all projects fail to deliver on the original schedule and budget. The biggest cause of these failures is attributed to either poor project scopes, or if the scope was well defined, scope creep. The good news is if the scope is defined clearly and scope creep is effectively managed, the chances of a successful migration improve greatly. Once you have the project scope defined, the next step is the planning phase. Project planning is the process of defining the specific activities and resources that will be needed for the system migration. During this phase you will define what tasks will be performed, who will perform the tasks, when the tasks will be performed, and what resources will be needed to accomplish the tasks. Requirements such as hardware, disk capacity, memory requirements, scalability, and other hardware capabilities should also be considered. When system migration projects fail, companies often blame the software, but the real reason they fail is usually because of poor project planning. Proper planning and following project

milestones will go a long way in ensuring project success.

Project Management – A Must Have Once you have the project scope defined and the project plan documented, the next step is to assign a project manager. A project manager is a dedicated resource that is accountable for the completion and ultimate success of the project. Unfortunately, many companies make the mistake of seeing the project management role as a nice to have, not a need to have. With organizations expecting projects to be completed faster, cheaper, and with higher quality than ever before, the project manager role is instrumental. A key benefit of having a project manager is they become a conduit for effective communication. The very nature of scoping out a project offers an agreed-upon course of action to obtain the desired result. In essence, that means everyone is on the same page from the start of the project. Ensuring a project stays on track requires constant communication with the various team members responsible for each piece of the overall project. That forced communication keeps everyone in the loop as the project evolves. A project manager is also responsible for keeping scoop creep from sabotaging the project. More often than not, the uncontrollable growth of a project plan is due to the lack of project management and almost always guarantees the downfall of a project. Alternatively, successful project management controls the flow of a project and

keeps team members focused on working within the original scope of work. Overall, a project manager provides the structured accountability that is needed to ensure the project is properly championed and stays on track and schedule.

Focus For Success There are numerous benefits in migrating to a new system, but many companies are still reluctant to do so. Companies fear migrations will take too long, be over budget, disrupt their business, and fail to deliver the expected benefits. This need not be the case. Focusing on these three key areas before you

start your migration project will dramatically increase the success of your endeavors and ensure a stable and seamless transition. Don’t just ask what you can do with your technology; ask what your technology can do for you. The answer you get may be challenging and require some hard work upfront, but with the right planning and top-down support, it will be far less painful than doing nothing. Roxana Safranek is Director of Marketing for LeaseTeam, Inc. She has more than 18 years of marketing and business development experience with 14 of those years being in the software industry. Roxana is responsible for marketing, communication, and business development for LeaseTeam. LeaseTeam provides solutions that flexibly manage the entire lifecycle of equipment finance contracts, for an array of business types, portfolio and ticket sizes, and financial products. (www.leaseteam.com).

canadianequipmentfinance.com | May/June 2014 | CANADIAN EQUIPMENT FINANCE

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Technology

The Power of Analytics Fine-Tuning Financing Decision Strategies To Reduce Risk And Aid Compliance By Janet Orrick

Why Fine-Tune Decision Strategies?

very day, equipment finance organizations must make critical, high-risk decisions to operate effectively in today’s rapidly changing business and regulatory environment. To outperform the competition, speed is always of the essence; yet balancing risk is just as important if a business is to continue to grow profitably. It is not surprising, then, that the use of ‘analytics’ is creeping into the consciousness of equipment finance as more and more companies discover that its predictive power speeds decision making by efficiently identifying credit risk.

By incorporating analytics into the decision strategy toolset, financing companies can pinpoint areas ripe for decision automation, reduce credit risk, and more easily keep pace with new compliance requirements making a positive impact on profitability. In fact, many financing companies already possess the key to formulating more effective financing strategies right at their fingertips. Most companies now store valuable customer origination data coming in from multiple sources around the organization, but lack the time, resources, and/or know-how to thoroughly analyze that data. That is where an analytic expert comes in. Analytics services, such as those offered by International Decision Systems, analyze customer performance data to help companies review their financial decision models and make any needed new strategy adjustments.

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What is Analytics? Analytics uses sophisticated data analysis tools to provide companies with customized and highly predictive measures of customer performance. Analytics is swiftly emerging as a key trend in equipment finance because it offers finance companies a means of carefully examining past customer performance data, highlighting recommended changes to current decision models, and embedding new capabilities into their origination processes so they can automate a greater share of financing decisions. Analytics, for example, helps identify customers with the highest potential for delinquency to be flagged for auto decline, and the best customers to target for auto approval.

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Demystifying the Analytics Process By comparing actual performance to predicted performance, financing companies can target customer segments which are not performing as expected and adjust their financing decision models accordingly to avoid making costly future mistakes in accepting highrisk customers and losing out on more profitable business. To examine a financing company’s origination performance, most analytics

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

experts will start with a review of their origination strategy by deploying a ‘Decision Strategy Review’. This review process often includes these components: ◉◉ A Waterfall Table to group applicants together logically by similar risk criteria ◉◉ A Strategy Review to compare how financing decisions met with actual performance outcomes ◉◉ A Model Validation to review underlying financial decision models and identify a need for adjustment or replacement ◉◉ A Swap Set Analysis to measure the benefits an updated model or strategy can provide by comparing the swapin customer populations against the swap-out customer populations. Matching the company’s expected results to actual performance data produces groupings of low-risk and high-risk customer populations showing the greatest potential for auto-approvals or auto-declines. For example, Figure 1 on the next page illustrates a group of customer scores by segment for Company ABC, with the lowest score in group A and the highest score in group G. It also shows where each group falls within the percentage of delinquencies over 60 days. The normal expectation would be that the lowest scores in group A would result in the highest percentage of 60+ days delinquent, while the highest scores in group G would result in the lowest percentage of 60+ days delinquent.


TECHNOLOGY However, the actual data revealed that several groups did not perform as expected. Some segments in the low score ranges had fewer ‘bad’ accounts and some segments in the higher score ranges had greater amounts of ‘bad’ accounts.

reflects a population that would have been declined using the old strategy, but is now better categorized as a low-risk ‘swap-in’ population using the new updated model. Conversely, group (D) has higher than average delinquencies and

60+ DAYS DELINQUENT

Figure 1

25% 20% HIGHER HIG HI GHER THAN EXPECTED EXPECTE EXPEC

15% 10% 5%

LLOWER OWER TTHAN HAN EEXPECTED XPECTED

0% GROUP

A

EXPECTED

GROUP

B

GROUP

C

GROUP

D

GROUP

E

GROUP

F

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G

60+ RATE

By viewing expected results compared to actual results, Company ABC has the information in hand to support the need to create new models, fine-tune existing strategies, and/or adjust data elements within the models and strategies. Analytics also demonstrates how Company ABC could benefit by updating their model to be closer in line with expectations. As shown in Figure 2, by overlaying Company ABC’s current risk model with a proposed updated risk model, four unique groups emerge in rank order – the old score ‘declines’ and ‘approvals’ versus the updated new score ‘declines’ and ‘approvals’. The first group (A) would be approved under both the current and the alternative strategy. The second group (B) would be declined in both strategies. The next two groups, however, show a much different pattern. One group (C), with low delinquency,

was misclassified as ‘approve’ in the existing strategy, but would be reclassified as ‘decline’ in the new strategy. Therefore, the analytics process would recommend that group (C) be ‘swapped-in’ and group (D) be ‘swappedout’ to improve Company ABC’s portfolio performance and reduce risk.

Potential Business Impact To measure the potential impact of changing decision models based on the results of the analytics process, a company’s initial sample set can also be run through a ‘what-if’ scenario to determine the total per cent of population that would benefit after applying each change. Some financing companies opt to use a baby-step approach to gradually explore ways to automate new selection strategies indicated by the use of analytics. They often continue to allow the majority of their application population to flow through a controlled (already proven) strategy, and then run a smaller portion of applications through a new test strategy. Once the new test strategy is proven to outperform the current one, the company replaces the old strategy with the new, better performing one. As time goes on, administrators can easily adjust thresholds for each selection criteria

Figure 2

The resulting analysis would help Company ABC understand how suggested strategy improvements could ultimately grow their business and justify the work that needs to go into making changes to their decision models.

by fine-tuning the strategy and models once they are in production. Advanced reporting engines also help companies better visualize data and keep tabs on realtime performance.

The Future of Analytics By effectively reducing the number of high-risk customers and increasing the volume of low-risk deals flowing through the origination process, ‘analytics’ is quickly becoming a must-have secret weapon in the fight to combat risk and boost profits in the global equipment finance industry. With the insight provided by analytics, financing companies can modify existing decision strategies and increase decision automation so they can extend credit more confidently and better respond to new compliance requirements in the future. With software performing more of the analytic heavylifting, underwriters can focus their time and effort on accounts that fall into neither the high risk (auto decline) or the low risk (auto approve) groups, creating efficiencies and productivity gains. Periodic review of decision models is a regulation requirement for banking institutions and is a best practice throughout the equipment finance industry. As the future unfolds, the science of analytics is poised to grow in importance as financing companies continue to look for ways to stay competitive while maintaining a well-balanced portfolio. Janet Orrick, Principal Analytic Scientist at International Decision Systems, brings with her more than 15 years of strategy management and predictive analytics, applying statistical modeling to develop innovative solutions to business problems. Prior to joining IDS, Janet held an assistant vice-president position at HSBC working with the Modeling and Analytic Solution group where she developed risk, response, and revenue models for the auto, mortgage, and retail credit card divisions. Janet found solutions for a variety of legislation issues including Regulation B, Basel II, and Dodd-Frank. Janet holds a Master’s of Business Administration (MBA) from University of Phoenix with a Bachelor of Science in Math and Business from Concordia College in Moorhead, MN.

canadianequipmentfinance.com | May/June 2014 | CANADIAN EQUIPMENT FINANCE

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your Business

One Bad Apple: How to Address – and Avoid – a Bad Hire By David King

here does the day go?” We’ve all asked ourselves this question. But few may realize the answer could lie in poor hiring practices. Supervisors spend, on average, 26 per cent of their time overseeing poorly performing employees, says a study by Robert Half Management Resources, a provider of senior-level accounting, finance, and business systems professionals. That’s more than one full workday a week. But the effects of a bad hire rarely end there. Of the more than 270 Canadian chief financial officers interviewed for the study, 83 per cent said an underperforming employee has at least some impact on the morale of the team, with more than half (56 per cent) of respondents revealing that team morale is greatly affected. Survey says: an underperforming employee will most certainly impact your bottom line — but to what extent?

W

The Cost of a Bad Hire While the financial repercussions of a poor hiring decision vary (How much

was the employee paid? How long did he or she remain with your company? How difficult is it to find a replacement?), the cost can be several times a bad hire’s annual salary. The buck, unfortunately, doesn’t stop there. In addition to direct expenses — things like travel or relocation, testing, and training — the soft costs associated with a bad hire include things like incomplete work and, worse, disgruntled clients. Another cost to consider is the supervisors and staff who must take time out of their busy schedules to pick up the slack for a misfit recruit. Besides potential overtime pay, this can lead to lost productivity and other work falling off track. Morale suffers and frustration builds. Members of your team may even become resentful if they sense their leader is not addressing the problem.

How to Address a Bad Hire Spotting a bad apple can be tough, particularly for senior leaders who are tied up attending to the needs of multiple staff. Certain telltale signs include

poor attendance, missed deadlines, and conflicts with co-workers. But what next? Subsequently addressing the issues behind poor performance can be difficult as well. Here are some tips for nipping poor performance in the bud: ◉◉ Intervene early on. Step in as soon as possible when an employee’s job performance is less than satisfactory. Failing to provide pointed feedback early on may result in that member of staff assuming that he or she is doing just fine. ◉◉ Communicate. Meet with the employee to discuss the issues. Focus on specific actions, explaining the cause-and-effect relationship between the unacceptable behaviour and the unacceptable consequence of that behaviour. Rather than saying, “You always miss deadlines,” mention how a report that was submitted late resulted in the loss of business for the firm. ◉◉ Discover the root of the problem. Try to find out what’s causing the performance issues. Is the employee overworked or dealing with a personal

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your Business matter that’s affecting his or her performance? Should responsibilities be reassigned? ◉◉ Discuss your expectations. Your standards should be attainable and, to that extent, feasible, and measurable. Explain to the employee how not meeting these expectations will affect the company’s operations. Give concrete deadlines for improvement, and follow up on those dates. ◉◉ Correct the deficiencies. Identify the tools the employee needs to better meet the requirements of the job. If further training is required, make sure it’s received. Clearly communicate what the consequences will be if the problem isn’t fixed. ◉◉ Put it in writing. Keep a record of the performance issues and your discussions with the employee. There could be legal ramifications to take into consideration, so work with your human resources representative as appropriate.

How to Avoid a Bad Hire The good news is that bad hires rarely happen by chance. Most can be traced back to a misstep in the recruitment process. Implementing certain best practices at the hiring level can help ensure the right person gets the job. The hiring process takes time. Skills assessments, thorough interviews, and reference checks must be completed, not to mention managing the offer process effectively. It may seem like a lot of work, but the results are worth it. The following tips can help.

◉◉ Don’t go it alone. Though you may have the final say, hiring should never be a solo effort. Ask colleagues for referrals and members of your team, especially those who will be working directly with the new hire, to help define the needed qualities for the job. ◉◉ Know what you want. Don’t recycle the job description you used last time you filled the position. The listing likely requires a fresh look, particularly when it comes to the types of skills you’d like to add to your team. A detailed job description can also reduce the number of resumes you receive from unqualified applicants. ◉◉ Seek soft skills. In addition to functional abilities, such as technical expertise, look for evidence that a candidate also has strong interpersonal skills. Failure on your part to take leadership, communication, and similar abilities into account may mean setting yourself up for a bad match. ◉◉ Cultural fit counts. More than just identifying a strong resume and exceptional qualifications, hiring involves establishing a rapport with each applicant in order to find the best cultural fit for your firm. During the interview, ask questions that can reveal a potential hire’s preferred corporate culture, such as – what sort of work environment they prefer? What brings out their best performance? Who their best boss was, and why? ◉◉ Woo your top choices. People in high-demand specialties usually have multiple job offers. Show

them why they should choose your organization by describing the benefits of working with your firm. Also, don’t overlook the importance of offering a compensation package that’s in line with — or, ideally, above — market rates. Stay current on prevailing trends. Once you’ve identified your top candidate, make an offer before you lose him or her to another opportunity.

Work with a Recruiter A specialized recruiting firm can help enhance and accelerate the hiring process while allowing you to focus on your core day-to-day responsibilities. A recruiter can identify top candidates you may overlook or not know of. He or she can also evaluate resumes, conduct skills testing, and perform preliminary interviews, saving you time and providing added assurance a prospective employee is a potential match. The most important asset any business has is its people. Taking shortcuts to build your team may ease immediate pains but create regrets in the long term. The key is to understand that hiring and developing the right candidate takes time. Be patient, develop a comprehensive hiring plan, and execute it flawlessly. The time, money, and frustration you’ll save by avoiding a bad hire will be well worth it. David King is the Canadian president of Robert Half Management Resources, a provider of senior-level accounting, finance, and business systems professionals to supplement companies’ project and interim staffing needs.

Information Technology Solutions

ADD Capital Corp. MarkhaM address: 500 Cochrane Dr., Unit 2 Markham, ON L3R 8E2 Bill Patterson (bill.p@addcapital.ca) 905 940-2151, ext 235

Burlington address; 5045 South Service Road, Suite 102 Burlington, ON L7L 5Y7 Dave Ralph (dave.r@addcapital.ca) 905 631-8001, ext 400

Common Sense Leasing • New Brokers Welcome • Reasonable solution to A credit declines canadianequipmentfinance.com | May/June 2014 | CANADIAN EQUIPMENT FINANCE

19


management Strategy

Accounting for the Purchase and Sale of Lease Portfolios A primer in lease accounting for buyers, sellers, and operators By David Chaiton

n the post-Enron environment, lessors are increasingly discovering that their usual forms of agreement for the sale or purchase of lease receivables are attracting an increased level of scrutiny. To a large extent, this is an unfortunate side effect of widely publicized abuses of the accounting rules by a small number of companies. But it is due, in part, to a recognition that certain practices have developed in the leasing industry in connection with the sale of lease receivables that are inconsistent with the notion of a non-recourse, off-balance sheet, true sale of receivables. To further complicate matters, equipment lease receivables often include a software and/or a service fee component. This can have a profound

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effect on the way in which a sale of receivables is treated under various accounting and true-sale legal rules.

Higher Standard of Care The issue of how to treat receivables in financial statements is an extremely important one for directors of companies as well, who are obligated to approve the financial statements prior to their submission to the shareholders of the company. The annual financial statements of public companies are also audited and reviewed by the corporation’s audit committee. Shareholders and creditors then rely on these statements when making their investment and credit decisions. Should the financial statements prove misleading, and the directors knew or ought to have known that they were

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

misleading and incorrect and that the plaintiff was within a predictable class of persons who might be expected to rely on the statements, then the offending directors might well find themselves on the unhappy side of a judgment holding them liable to the reliant injured party. Furthermore, given the sophistication of modern leasing businesses, directors will increasingly attract and be held to a higher standard of care by courts in these types of lawsuits. So too, they may be drawn into situations where investors, secured creditors, governmental authorities, and other ‘beautiful losers’ who in the past simply fell from the vine whenever insolvency occurred, now find the courts receptive to allegations of misjudgment, or worse, and the search for deep pockets intensifies. Words like ‘fraud’ are often tossed about with


Management Strategy

“As a threshold matter, the lessor and the buyer should ask whether ‘true sale’ treatment is appropriate for the transaction in question.” abandon as the investigators complete their task. More often than not, the central issue in the inquiry will be one of accounting and the prodigious efforts that were made to circumvent one potential treatment or another, efforts which in the absence of insolvency or some similar disaster would be hailed as innovative, creative – even ingenious. Ever amorphous, and far from ‘bright’, the line dividing fair presentation from misrepresentation emerges in the clear light of hindsight as one allegedly well known, forever understood, and now crossed with the foul deception of selfserving, manipulative, ill-conceived, deliberate shades of meaning actively deployed to lull the innocent into slumber. Or so they say…

Well-Documented Management The point here is that the directors and officers of leasing companies need to recognize and internalize the need for knowledgeable, conservative, and well-documented management. To some that would seem an impossible task if for no other reason than the fact that others appear to be engaged in the same type of transactions, assuming risks that carry the just entitlement of reward for those clever enough to exploit them, and dismissal for the rest if inaction results in competitors assuming dominant positions in the marketplace. Here, then, are the basic accounting rules to apply under Generally Accepted Accounting Principles (GAAP)1: As a threshold matter, the lessor and the buyer should ask whether ‘true sale’ treatment is appropriate for the transaction in question. As a general rule, in order to have a true sale: the buyer must not have excessive recourse to the lessor; and the lessor must be willing to give up control over the

lease portfolio, including the right to any possible upside in the portfolio. Otherwise, the transaction looks more like a loan and should be treated as such under the applicable accounting rules. For a variety of reasons, a nonrecourse true sale may not be feasible in certain situations. The following outlines a few examples. ◉◉ Lessee Credit Risk The buyer may not be willing to accept the credit risk of the more challenging lessees in the portfolio without recourse to the lessor. With limited exceptions, in order to be a true sale, the sale must be without recourse to the lessor. ◉◉ Control by the Seller – Recapture of Upside The lessor may not be willing to give up the potential upside in the portfolio and may desire an option to buy the portfolio back. With limited exceptions, the lessor must be willing to give up not only control over the portfolio but also the ability to obtain the upside if the lessor wants to have the transaction treated as a true sale. ◉◉ Legal and Documentation Risk In some heavily negotiated lease transactions, the underlying lease receivable may not constitute a firm, non-cancelable payment obligation of the lessee. For example, the lease may not contain a strong hell-or-high-water clause or waiver of defenses against assignees. Another example is where a lessor who is also the manufacturer uses a combined form of lease and maintenance service agreement. If the agreement is not properly drafted, a maintenance breach by the lessor can lead to a defense to payment of rent by the lessee. Indeed, in certain types

of transactions, such as consumer finance, it may be impossible to separate service/warranty performance from the payment obligation under a lease. In commercial lease transactions it is unlikely that a buyer will be willing to purchase a lease portfolio without recourse to the lessor if the leases can be canceled upon a performance breach by the lessor. ◉◉ Performance Risk Sometimes the receivables are ‘future receivables’ that do not exist at the time of transfer and have not been earned by performance of the lessor. Receivables that relate to future service obligations or future deliverables that have not been earned by performance may be difficult to sell on a nonrecourse basis. A buyer is often willing to accept lessee credit risk but not the risk that the receivable may not exist or be enforceable. In all the foregoing examples, either there are risks inherent in the lease receivables that the buyer is unwilling to assume, or the lessor is not willing to give up the potential upside in the asset for the price that the buyer is willing to pay. Added to these, of course, is the fact that sellers and buyers often have incompatible goals in embarking on the deal, which frequently leads to distortions in the documentation that obscure or confuse the transactional characterization requirements of the parties. As a result, the buyer may not be willing to purchase the lease receivables without recourse to the lessor, or the lessor may not be willing to give up control over the lease receivables. In any of these cases, the parties should acknowledge the situation at the outset and not try to get off-balance sheet and true-sale treatment which would raise issues with respect to the recording of the transactions on the corporation’s books of which the officers and directors must be cognizant.

True-Sales For accounting purposes, the existence of a true sale primarily turns on two key questions:

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management Strategy ◉◉ Has the risk of loss shifted to the buyer? In order to constitute a true sale, the buyer must assume the risk that the lessee is financially unable to pay on the lease receivables. In other words, the buyer must not have excessive recourse to the lessor. Prohibited recourse can take many forms, including direct recourse, contract damages, put rights, holdbacks from the purchase price, reserves, guaranties, collateral, or subordination of other payment streams owned by lessor. Some forms of limited recourse are, however, permitted but their availability must be scrupulously analyzed. ◉◉ Has the buyer acquired the benefits of ownership of the lease receivable? In order to constitute a true sale, the buyer must be entitled to all the benefits of ownership, including any upside inherent in the lease receivables. For example, if the lessor sells a lease rental stream at a time when discount rates are high, the lessor might like the idea of having a repurchase right so that the lessor could repurchase the receivables and refinance them at a lower rate if discount rates should drop. However, this degree of control over the lease receivables and ability to recapture upside is inconsistent with the notion of a true sale. Although these concepts may appear simple and straightforward, the truesale analysis in a typical lease portfolio sale transaction can become quite complicated. The following list shows that the true-sale characterization of a transaction requires careful consideration of all the facts and circumstances, so in many cases no single factor is determinative: 1. intent of the parties – both words and conduct 2. notice to the lessees of the assignment – notice is indicative of sale 3. representations and warranties – should speak as of date of transaction, not prospectively – none should be made as to collectability or financial inability of lessees to pay 22

4. covenants – ongoing covenants are dangerous to characterization as true-sale transaction – as a general rule, covenant breaches should not give rise to a put or other recourse that may lead to a return of the purchase price 5. security interest in the leased equipment – should ensure that the excess value of the equipment over and above the present value of the remaining rent does not secure other amounts independently owed to the buyer by the seller (‘crosscollateralization’ in loan parlance) 6. prepayment rights for upgrades or early terminations – effectively allow refinancing of lease receivables at lower discount rate and for a higher price if interest rates drop and therefore would appear to be inconsistent with the notion of a true sale 7. maintenance of leased products – breach must not give rise to a right of the buyer to put the purchased lease receivables back to lessor or a right to some other form of recourse – better to have right to replace service provider if that would help to mitigate future losses 8. collection of lease receivables – if by lessor, may look like a loan – however, may be outweighed by other factors such as direct notification to lessee, retention of right to assume administration upon lessor’s default, for example 9. cost of enforcement of the lease – one of the risks accepted by buyer in a true sale, therefore, lessor must be careful that it does not inadvertently end up bearing the costs of enforcement, for example, where residual interest of lessor and/ or service fees are subordinated to buyer’s recovery of costs 10. remarketing of equipment on lessee default – permitted under true-sale analysis so long as for market rate compensation 11. repurchase or put rights – if too broad, transaction looks more like loan 12. indemnities from the lessor – may be acceptable for third party claims such as patent indemnity, but should not go too far

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

Lease Classification under GAAP In accounting for a lease transaction, one must first classify the lease as an operating lease or a direct financing lease. Basically, if the lease is a direct financing lease, the present value of the minimum rent is referred to in accounting parlance as a ‘finance receivable’. Under a direct financing lease, if the lease rents are assigned to a funder, it is possible to record an immediate sale of the finance receivable that is generated by the lease. However, if the lease is an operating lease and the rental payments are assigned to a funder, the transaction cannot be treated as a sale of a receivable. The proceeds from the assignment must be reflected as a debt on the balance sheet of the company. The difference is quite important in both balance sheet disclosure and in income calculation. There are a number of circumstances where GAAP does not permit the recognition of income on a bulk sale of leases, many of which are detailed elsewhere in this presentation. In dealing with revenue recognition it is essential to ensure that recourse losses are both limited and accurately estimated, and that there are no de facto practices of, for example, repurchasing leases in default whether or not the company has a recourse obligation to do so. Also, the recording of a discounted stretch value (DSV) and other residual values on leases may indicate there has been no transfer of the risks and rewards of ownership.

Initial Direct Costs (IDCs) In accounting for leases, it is appropriate for the lessor to record the direct costs incurred in acquiring a lease as an expense of the accounting period. To avoid showing an operating loss merely through the acquisition of leases, it is also appropriate to record sufficient income to exactly offset the initial direct costs. Initial direct costs, defined in the CICA Handbook, s.3065.03(1), are restricted to costs directly associated with negotiating and executing a specific leasing transaction and exclude supervisory and administrative costs, among others.


Sample Head Management Strategy Allowances for Doubtful Accounts It is normal in accounting to record a provision for lease losses, or bad debts, as an expense in the income statement and as an increase in the balance sheet valuation account for finance receivables called the ‘allowance for doubtful accounts’. Every entry in accounting has two parts (thus, ‘doubleentry accounting’). If you wish to reduce the value of finance receivables, you do so by both an increase in an expense (bad debt expense or provision for doubtful accounts) and a deduction from the finance receivable balance. When a specific lease is identified as a bad debt and the amount of loss is determined, the actual loss is recorded as a reduction of finance receivables balance and a reduction of the allowance for doubtful accounts balance (called a ‘bad debt write-off’).

Income on Finance Leases – Sum of the Digits Versus Actuarial Basis GAAP requires income on a finance lease to be recorded in a manner similar to interest on a loan. This is referred to as the actuarial basis. This method results in income being recognized over the lease term on a basis that produces a constant rate of return on the investment in the lease. In contrast, the ‘sum of the digits’ (SOD) method to record interest income (which is called finance income) provides a close approximation of the actuarial method for shortterm leases that do not

have a residual value. The calculation assumes equal periodic payments to totally amortize the unearned income on a lease. This would be similar to the method used by a bank when it receives equal periodic payments on a car loan but where there is no balance of principal left at the end of the loan period. Where a lease portfolio contains leases with quarterly or other non-monthly payment terms, or with high recorded residual values (such as a large portfolio of automobile leases with significant recorded residual value), the use of the SOD method rather than the actuarial method to record finance income on these leases would overstate income in the early years of the lease term. The overstatement is offset by an understatement of income in the later years of the lease term – only the timing of recording the interest income varies.

on revenue recognition as well as to the lease accounting section, s.3065. It would only be proper to record such income in the period in which it is received but not earlier. Accordingly, since GAAP does not permit the recording of contingent gains, this practice distorts financial results by artificially increasing income.

Conclusion As you find yourselves regaled with the delights of lease accounting, it is well worth remembering that the failure to comply with these standards may result in more than mere embarrassment when creditors and investors are left in the lurch in any insolvency, or following a reassessment of tax (under several statutes

which depend upon clarity in characterization and consequential reporting). It is a tangled web that has been woven, a slippery slope for those who begin on the wrong foot, and a bad day for all of us when the sheriff arrives at our doorstep carrying bundles of wildly enthusiastic love notes from aspirants of every stripe – the appalled, the crushed, the victims – or just plain enthusiastic plaintiffs who will compete vigorously for their ratable share of your financial estate. ABOUT THE AUTHOR: David Chaiton is widely recognized as an expert in equipment financing, leasing, assetbased lending, corporate finance, and banking matters, has been involved in complex bankruptcy and receivership engagements and represents banks, insurance companies, leasing companies, and other purveyors of financial services. A former director of the Canadian Finance & Leasing Association, David was a member of its legal committee and was recognized for his contribution to the development of the vehicle leasing and equipment finance industry in Canada when he received its member of the year award. 1 Consideration of the new rules under discussion is beyond the scope of this primer.

Residual Values – DSVs In preparing their financial statements some leasing companies have adopted the ‘aggressive’ stance with respect to bargain purchase option leases – that some lessees would fail to exercise such options causing the leases in question to fall into stretch or overhold periods. While it is not unusual at the end of the term of small ticket leases for the termination date to be forgotten by a lessee, it is not appropriate, however, to assume at inception of the lease that the lessee will continue to make lease payments beyond the expiration of the initial lease term (‘post-diem payments’), and to record this estimate in income. This is contrary to s.3400 of the CICA Handbook canadianequipmentfinance.com | May/June 2014 | CANADIAN EQUIPMENT FINANCE

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management Strategy

The Next Generation: Transition and Succession Planning Insuring success and preventing extinction in the decades to come

By Robert D. Katz, Michael Dervis, and Richard Hauer

manufacturing company located in multiple provinces has been financing its equipment from the same lender for the last twenty years. Throughout that time, and through the ups and downs of the economy, the company has always made its payments on time. Likewise, all reporting has been done on a timely basis and variances to the company’s forecast are always explained in great detail. Most importantly, management regularly shares its visions and business plans before any expansions or significant changes. The company is a model customer and has an excellent relationship with the lender.

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The company’s credit facility was up for renewal and, as usual, the lender requested a meeting to go over the terms of the renewal. During the renewal discussions, the company’s owner mentioned that he was planning on retiring and that he would be turning the operating responsibility over to his two children. Although the children had been working in the business for quite some time, they had not previously participated in renewal discussions with the lender and had not built a relationship with the bank. The owner’s decision plan was quite concerning to the lender and it raised many questions regarding the capabilities of the children

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

– and ultimately the future value of the company. It did not appear that there was a clear, well thought-out succession plan.

Assessing the Future Plan With a majority of family owned businesses, a properly thought out transition/succession plan is often the difference between future success and failure. The challenge is one of how to approach the subject. There are five important considerations: 1. Are competent leaders/managers in place under the owners and are they capable of taking over and leading the company?

Recently, a restaurant chain with eight


Sample Head Management Strategy locations faced this exact question. All of the managers had been with the company in a leadership capacity for seven or more years. The CFO had been with the company for 10 years. Although it was never stated, it was clear that the next level of management had the necessary industry and company experience to step in, direct, and lead, and they had the experience and expertise to assist the owner’s next generation. 2. Does the succeeding generation have the same keen work ethic as the owner?

Observe how the employees treat the family members; most likely they will treat them differently. Often you can see differences, subtle as they may be. Remember that respect is earned and rarely, if ever, automatically given. If as the lender, you are relatively new to the situation, challenge other members of the company’s management team about their understanding of a succession plan. Take the time to really listen to their answers; listen to what they may or may not be saying. In a lot of cases those who started and grew the business had a strong work ethic. The next generation owners sometimes do not share the same work ethic – yet believe they are entitled to the same rewards. If the next generation has the same exceptional work focus as the founder, the organization certainly is in good standing and the lender can have confidence while being a part of the strategy that makes the transition and succession a success. 3. Is ‘key person’ life insurance in place?

There is nothing wrong with asking this question as part of normal diligence and review. If there is a policy in place, make every effort to determine if it is a ‘token’ policy or enough to insure continuity. The answer will give you some initial indication about next steps. The follow up question should be whether the company previously had life insurance in place or was it forced to have life insurance as a requirement of a lender. A company that puts life insurance in place on its own gives indication that it has given real consideration to its succession planning.

4. Is owner/family compensation proportional to contribution? Is it affecting free cash flow?

Sometimes family members think it is their born right to have a job at the company, along with job security, a car, and numerous other benefits. A lender’s diligence or update process should analyze what is truly being distributed. It should consider this in a broad perspective, including all benefits – cars, entertainment spending, travel, country club dues, and any expenses that are associated with the individual’s personal life. In a recent situation, the chairman’s salary was more than the combined income of the CFO/COO and all the EVPs, yet his contribution was not proportional. While it is a very difficult conversation to have, it is a necessary one. 5. What is the operating vision for the future?

One of the most significant differences between companies that are successful for multiple generations and ones that are not is the vision of the leadership and executive team. That includes being proactive and looking forward and addressing the trends before they occur rather than being reactive and on the heels. As the lender, find out where your borrower stands. It will undoubtedly raise a multitude of follow-up questions and considerations that need to be addressed and will give you a strong indicator of the company’s ability and probability of succeeding through the next phase.

Consider the Team Succession planning is not just about one person – it’s about the whole executive team. There must be a plan for each executive in order to eliminate loss of productivity and direction. Consider three situations. The first occurred while conducting interviews for a full time chief financial officer to replace me as the interim CFO. The controller, a family member, asked why he wasn’t being considered for the position. I told him that from what we had observed, I wasn’t comfortable and prepared to place the livelihood of the company and its 350 employees in his hands. It was a tough conversation, but one that needed to be had. In the second situation, a family

member graduated from college and then spent the next 20 years learning every aspect of the business. He started as a summer intern. He was the first to arrive each morning and the last to leave at the end of each day – after he finished sweeping the floors. In between, he learned and performed all the other tasks. He then spent the next 19 years learning the administrative and operational functions and was capable of doing all jobs. Only then, and after a long and extensive interview process with the board members, was he deemed capable of leading the company. Compare this with a third situation where one of the family members in a company believed he was ready to step in as CEO despite lacking certain pertinent qualifications. For instance, he had never been responsible for more than two people at any one time and didn’t have any direct decision making responsibility. Clearly, his most notable qualification was that a family member was one of the owners. However, there is no substitute for hard work.

Looking for Longevity Sometimes people are a bit taken aback by questions regarding succession planning and the next generation of leadership; they may even be somewhat chagrined at having to have the conversation. However, the hope is that the owner understands that the questions are sincere and the concern is for the longevity of the company and its employees, as well as the family. By following these guidelines, asking the difficult questions, and doing due diligence, lenders can ensure that they are a part of a sound business plan and success strategy and that they will be able to continue doing business with companies through multiple successions and shifts in management. Robert D. Katz, CTP, CPA, MBA is president of Executive Sounding Board Associates LLC and is part of the succession plan. He has acted as an interim restructuring officer for companies both in and out of bankruptcy. He sits on the CFA’s Education Foundation; is a former TMA executive committee member and a current board member. He is also an Adjunct Professor of Finance and Strategic Management at Temple University. He can be reached at rdkatz@esba.com. Michael Dervis and Richard Hauer are managing directors at Executive Sounding Board Associates LLC. Robert, Michael, and Richard have all led numerous operational and financial turnarounds for both publicly traded and private companies, generating substantial cash flow and operating improvements. Executive Sounding Board Associates LLC are management and financial consultants located in Philadelphia, PA. www.esba.com.

canadianequipmentfinance.com | May/June 2014 | CANADIAN EQUIPMENT FINANCE

25


Sector Report

The Road to Technology Transformation Business best practices and rules can help businesses to adapt and leverage ever-advancing technologies By Vladimir Kovacevic

ot even a month ago I had an interesting conversation with my 11-year-old daughter. As we were getting into the car, I pulled a CD from my bag and was ready to put it into the car’s CD player when my daughter asked me a simple question: “What is that?” It took me a few seconds to answer as I was trying to figure out if she was serious. “Surely you must know what this is – it’s a CD.” My comment was returned with a blank stare and the conversation that followed centered on “Why would anyone use that when you can download all your songs?” This made me think about several things, but one thing that I keep coming back to is that she and her friends will be entering the workforce in the next eight to 10 years. This raises several interesting questions. Are today’s companies ready to meet the expectations of the younger generations in terms of the technology they use? How can a business take steps today to ensure that there is a long-term benefit and alignment with upcoming technological advances?

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Adapting Is Essential The reality is that technology is advancing at an exponential rate and this means that businesses need to be able to adapt at the same rate. As an example, let’s look at the history of hard drive storage. In 1956, IBM introduced a hard drive that was the size of a refrigerator, weighed more than a ton, and it had a capacity of 5MB – roughly the size of a single song. It took us another 50 years to get to the point where hard drives were small and built into personal computers; but, they were still on average about 100MB in size. However, 10 years later hard drives are now built into everything 26

– from a key chain to a pen, and can hold terabytes of data. Can you imagine what the next 10 years will bring? How can businesses keep up with the rapid advances in technology and growing expectations of the young adults that are going to be entering the workforce in the next few years? Like with most complex issues, there is no ‘silver bullet’, no guaranteed solution. However, there are certain best practices and rules that can be followed to ensure that businesses will be in position to adopt the latest technology and take advantage of it. These practices focus on ‘how’ rather than ‘what’ because ‘what’ keeps changing from year to year.

Rule #1 – Vision In order to achieve any goal we have to be able to visualize it. This critical first step is often the one that is the most problematic and there are two reasons why. First, it is often overlooked and companies simply start to implement the best and latest technology only to find years later that they have gone down the wrong path and that it’s very costly and difficult to make a correction. Secondly, even when companies do try to set the technology vision, they are faced with an overwhelming number of options and don’t have the right resources to help with the long term technology strategy and vision. What is the best way to set the company’s technology strategy for the next five years? It comes down to people. For a smaller company it may mean relying on outside consultants and for larger businesses it may mean relying on its in-house CTO/CIO. In either case, it is absolutely critical that those responsible for the technology vision and strategy also have expert level knowledge and understanding of the business. Without this ability to bridge the gap between the vision for how technology will be best

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

leveraged, the business will never be able to take the full advantage of technology and there will always be a disconnect between the needs and the capabilities.

Rule #2 – Documented Plan The simple but important task of documenting the strategy and vision shouldn’t be underestimated. Taking the strategic vision and creating a written plan forces all parties involved to think about schedules and budgets. This often leads to small but important changes to the plan and ensures that there is good alignment between what’s theoretically possible and what the company can afford to do. It is also important to keep in mind that this documented plan is not a detailed project plan that outlines the next five years of tasks and activities. Rule #3 explains why something like that shouldn’t even be attempted. The plan is simply a high level outline of all types of technology that go into establishing a solid base for future growth. It covers things such as phone systems, infrastructure, staffing, software licensing, whether the company should be hosting the hardware or considering outsourcing, and should a company be buying, leasing, or a combination of the two? This plan needs to be thought of and written as a framework. A high-level road map that clearly outlines the strategic vision, but is flexible enough to adapt to new technologies and new business directions.

Rule #3 – Phased Approach Too many companies embark on a ‘strategic technology transformation’ that will take five years to complete and the first implementation of the new technology platform is in year three. This rarely ever works out as planned. There are several simple reasons why. For


Sector Report starters, the technology itself is changing and moving so fast that what was a perfectly reasonable plan at the onset of the project may be completely obsolete by year three. Secondly, to create a detailed five-year implementation plan will take at least six months – this is a huge drain on the resources and since the business doesn’t stop during that time, additional dedicated project staff need to be brought on board. This raises what is guaranteed to already be a hefty price that comes with any five-year project. Instead, it is easier and simpler to think of the road to transformation as a series of small journeys. The best example for this comes from a remarkable story of Colin and Julie Angus. They set on an amazing adventure with a goal to circumnavigate the globe using exclusively human power. The journey took almost two years to complete and it was filled with unexpected and unknown obstacles that included rowing across the Atlantic in a wooden rowboat and facing two hurricanes. I had a chance to meet Colin and Julie, and in listening to their stories of how they prepared and how they handled the unforeseen obstacles it made me think that there is an uncanny similarity between what they had to go through and what a typical business may have to go through during the technology transformation project. One thing that Colin and Julie made very clear is that there was no way they could have ever thought of all possible issues they may face and prepare for them in advance. But what they could

do is have a road map and milestones that ensured they were on the right track. The road to technology transformation is similar and no less treacherous; but having a good strategic plan and vision that is used to establish a documented framework makes it possible to implement a series of smaller projects that, in the end, will take the company through the transformation and have it emerge better and more successful than what was ever thought possible.

Rule #4 – Do not reinvent There are many sayings that convey the same message – there is no need to reinvent something that already exists and works. The whole modern society is based on building on what previous generations created and as Sir Isaac Newton famously said, “If I have seen further it is by standing on the shoulders of giants.” Good strategic vision takes this into consideration and is based on taking the best possible technologies available and combining them in new creative ways to maximize the value they bring. Too many companies go down the path of developing and creating their own custom software. This is something that is not surprising and often happens with companies that are big enough to have internal IT resources. While there are exceptions that are justified any such project should be carefully considered and the company should carefully review the needs and existing solutions before embarking on a custom software project.

These projects are often underestimated and result in missed deadlines, budget over-runs, and eventually with a software package that is difficult to support and always two steps behind the current technology.

Rule #5 – Review, Adapt, and Correct One of the most important benefits of having a written framework and implementing through a series of smaller projects is that it’s possible to stop and reflect. This is an absolutely critical step on the road to transformation and should be done after every implementation and no less than once per quarter. Technology changes, business goals change, and people change – without

being able to stop and reflect on the road already taken it would not be possible to reach the end goal of a technology transformation and still be aligned with the business needs. While the road of technology transformation can be seen as difficult and scary, it is also a great one. Companies that dare to take this journey and follow some basic and simple principles come out of it transformed – not only on the technology side but the business side as well – and just like life, technological transformation is about the journey, not the destination. Vladimir Kovacevic is a chief technology officer at Inovatec Systems. Inovatec specializes in providing innovative software solutions and helping businesses establish a scalable, data driven business model within the automotive and equipment finance industry.

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Canadian Equipment Finance magazine serves more than 7,000 individual executive readers, who are responsible for upwards of $102 billion in equipment financing across the entire Canadian industrial and commercial asset-backed marketplace. To advertise contact Brent White brent@canadianequipmentfinance.com

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CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com


events

WHERE TO GO. WHAT TO SEE.

Find out more about the conferences, exhibitions, seminars and meetings in your industry April 9-12

May 7-9

Factoring Association 20th Annual Factoring Conference San Francisco, CA www.factoring.org

Equipment Leasing & Finance Association Public Sector Finance Forum Washington, DC www.elfaonline.org

April 23 Equipment Leasing & Finance Association ELFA Bank Best Practices Roundtable Chicago, IL www.elfaonline.org

April 23 Equipment Leasing & Finance Association ELFA Captives Best Practices Roundtable Chicago, IL www.elfaonline.org

April 23 Equipment Leasing & Finance Association ELFA Independent Best Practices Roundtable Chicago, IL www.elfaonline.org

April 23 Equipment Leasing & Finance Association ELFA 26th Annual National Funding Conference Chicago, IL www.elfaonline.org

May 1-3 Nat’l Assoc of Equip Leasing Brokers NAELB 2014 Annual Conference Orlando, FL www.naelb.org

May 4-6 Equipment Leasing & Finance Association ELFA Legal Forum Washington, DC www.elfaonline.org

Whistler, BC www.cfla-acfl.ca

September 14-16 IFO Canada 4th Annual Canadian Financial Operations Symposium Vancouver, BC www.financialops.org/canada2014

May 14-15 Equipment Leasing & Finance Association ELFA Capitol Connections Washington, DC www.elfaonline.org

September 18-20 NEFA 2014 Funding Symposium San Antonio, TX www.nefassociation.org/

June 1-3 Equipment Leasing & Finance Association ELFA Credit & Collections Management Conference Cincinnati, OH www.elfaonline.org

June 1-8 Credit Scoring & Risk Strategy Association 21st Annual Conference Niagara Falls, ON www.csrsa.org

September 19-20 Pacific Heavy Equipment Show Abbotsford, BC www.PacificEquipmentShow.com

October 19-21 Equipment Leasing & Finance Association ELFA 53rd Annual Convention San Diego, CA www.elfaonline.org

November 12-14 Commercial Finance Association 70th Annual Convention Washington, DC www.cfa.com

September 8-9 Equipment Leasing & Finance Association ELFA Operations & Technology Conference Atlanta, GA www.elfaonline.org

2015 February 8-11, 2015 ABS Vegas 2015 Las Vegas, NV www.imn.org/

September 8-10 Equipment Leasing & Finance Association Lease & Finance Accountants Conference Atlanta, GA www.elfaonline.org

March 5-6 National Heavy Equipment Show Toronto, ON www.NHES.ca

April 30 - May 2

September 10-12 Canadian Finance & Leasing Association CFLA Annual Conference 2014

NAELB Annual Conference Phoenix, AZ www.naelb.org/

Visit us online www.canadianequipmentfinance.com/events.html canadianequipmentfinance.com | May/June 2014 | CANADIAN EQUIPMENT FINANCE

29


Observations

Nine hundred and forty photographs in Whitehorse With email limits, how do you get those images from here to there? By Rob Birnie

omputers are just another fad, and they’re on their way out! The technologically challenged people among us cling to this idea with their very being. Unfortunately, the often quoted prediction by the chairman of IBM in 1943, “I think there is a world market for maybe five computers,” has been proven quite wrong. As computer technology has morphed from desktop dinosaurs into the latest state-of-the art pocket devices, a common challenge has faced real-world users of the technology. How do you get information from ‘here’ to ‘there’? Back in the day, networking was limited to sharing information between computers within the same building unless you used dialup – gasp – with the fastest connections being about one per cent of the speed of modern networks. The isolation of the computer data reduced the practical benefits of computer systems to a ‘glorified typewriter’ for the typical appraiser. Internet connectivity has clearly changed the picture. It is inconceivable in today’s world to be more than a few steps away from internet connectivity (because everyone has to update their Facebook status at the top of the hour); however, this worldwide connectivity and the tremendous advancements in technology have resulted in a few unexpected challenges in the appraisal world. Digital photography is a key area of improvement. A few short years ago, we reviewed a report which had 5x7 photographs taped to pages, annotated

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with post-it notes and fluorescent highlighting. Today, most appraisals require photographs of the equipment condition as well as pictures of serial numbers and hour meters. These reports are bringing risk management teams into the field, allowing them to actually see equipment installed and in operation. Unfortunately, the prolific use of digital photographs to augment an appraisal report has resulted in a significant unexpected challenge – much like in the ‘90s, it is still difficult to get information from ‘here’ to ‘there’. In 2000, state-ofthe-art digital cameras produced a two megapixel image. The typical photo size has doubled every five years since then, resulting in today’s cameras that produce 15 to 20 megapixel images. Even cellular phone cameras (which have historically produced poorer quality images) are approaching 10 megapixel in size. The downside of capturing pictures that illustrate the collection of cobwebs in the corner of the engine bay is that these files are huge.

longer a viable alternative as most email servers limit the total message size to 10 to 15 megabytes – that can be as few as two to three photos. Emailing a complete digital appraisal report which could include more than 500 photographs is effectively impossible. ‘Cloud’ storage offers an immediate solution, although the service offerings are in their infancy. Until recently, these services were focused on allowing one user to share pictures across multiple devices, however as data volumes have increased, services are being introduced which provide a real answer to one of our biggest challenges in producing a modern equipment appraisal – that being “we have 940 photographs of equipment in Whitehorse – how can we get this information over to you this afternoon?” While I think we’re all happy to bid good riddance to fads like boom boxes and oxygen bars, there is no question that computers and technology are here to stay. And, I’m quite sure that once everyone becomes comfortable sending

“Emailing a complete digital appraisal report which could include more than 500 photographs is effectively impossible.”

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Email has always been the only method that could be relied upon to send photos. Sending 15 to 20 two megapixel images (with compression) is quite simple using standard email clients; however, most email systems impose limits on message sizes. With the increase in megapixel counts, email is no

CANADIAN EQUIPMENT FINANCE | may/June 2014 | canadianequipmentfinance.com

large photographs, we will be facing the challenge of including full motion video of equipment in our reports! About the Author: Rob Birnie is a Certified Machinery and Equipment Appraiser (CMEA), Master Marine Surveyor (MMS), Senior Business Analyst (SBA) and an active member of the Vancouver Board of Trade. Rob has applied his hands-on experience in mechanical and marine repairs and more than 19 years of insurance damage appraisal, valuation and loss settlement experience to create and direct Verus Valuations. He doesn’t mind the snow. Much.


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