If you get rich

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If you get rich

Name Studentnumber University Faculty First supervisor Second supervisor

Date Place

If you get rich from horses, you will never be poor……

(Dutch expression)

Regien Adema Studentnumber 1449508

University Rijksuniversiteit Groningen Economics and Business First supervisor Prof. Dr. P.S. Zwart Second supervisor Dr. C.K. Streb

August, 2010 Groningen

Regien Adema and True

horses, you will never be poor……

Regien Adema and True diamond

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Preface

After a period of eight months and much research, I have come to the end of my research into

equestrian leasing. Although it was a difficult research subject because of the complexity of leasing in general and the non-transparent horse market, I belief that this research has been an eye-opener for possible future opportunities and a pleasant way of completing my study at the State University, Groningen.

I could have selected the easy way by only focusing on literature study with the support of a company and the prospect of a job. However, my aim was to combine my own creativity and entrepreneurial spirit in forming a business concept, whereby I could assist people with financial baggage in shaping a sports career. Besides, the motivation was finding a win-win situation; creating a favorable financial situation for investors and users and at the same time being socially responsible. An entrepreneur does not choose the easiest road, but the smartest.

I would like to thank those who has given me much advice and support during the time of writing my master thesis. Firstly, I would like to thank my thesis coordinator Mr. P.S. Zwart for his clear advice and supportive attitude towards my “idea”. The way of supervising was pleasant, flexible and highly instructive. Secondly, I would like to thank my boyfriend, Kenny, for his critical notes and feedback during my research. Thirdly, the feedback from my fellow students regarding the questionnaire was very helpful, thank you! Fourthly, without the interviewees the research would not have been complete and I would therefore like to thank Miss. Sipsma and Miss. Reinders, but also Mr. Van der Meer and Mr. Franken. Furthermore, many thanks goes to the students of the Deurne Equestrian School for Higher Vocational Education. Lastly, I would like to thank my father and mother for their support and assistance during my whole study period.

I hope you, the reader, will enjoy this thesis.

Regien Adema

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Executive summary

Motivation

Financing and finding a top quality horse are the main reasons for disturbing the dreams of the athletes (Shurink,2009). However, a lot of money circulates in this industry and the market is growing which offers business opportunities. The main idea for this study was to develop a lease construction for funding high quality sport horses for those with talent, but who do not have the resources. The motivation for this research is the increasing interest in equestrian sport. Based on the reasons mentioned above the following research question was developed:

“Is a quality horse a suitable lease investment for the lessor and lessee and which lease construction should be developed? “

The research question is supported by several sub-research questions which are divided into three parts: opportunity screening, the lease perspective of the lessee and the lessor. These parts form the theoretical background of the research.

Theoretical framework

The main motive of the second Chapter is to describe the criteria which are decisive for a successful firm. An opportunity is distinguished from an idea when the gap in the market is filled and it has money making characteristics. The third Chapter presents the different lease types. Operational leasing is based on using the asset but not owning it, which is the basis for financial leasing. The reasons for lessees to consider leasing vary from financial motives to risk sharing advantages. The last Chapter of the theoretical framework describes the leasing segments which are attractive for the lessor (small businesses and consumers). Furthermore, the investor has to also take into account the suitability of the leasable object and the financial consequences. A lessee who is emotionally attached to the horse will not lease but purchase the horse, so the alternatives need to be considered.

Conceptual model, hypothesis and methodology

Subsequently the foundation for the research is set up, namely the conceptual model and eight hypotheses. The input for the conceptual model is the theoretical framework. The hypotheses will be tested through desk and field research, and a survey regarding the experience amongst 40 students of the equestrian school in Deurne will give a broader perspective (the sample reflects two-subsamples, namely athletes and start-up companies) about their behavior and opinion regarding leasing.

Furthermore, the desk research and academic literature will support the market and economical facts.

The personal interviews with entrepreneurs, teachers and horse institutions will also give a different view on the horse industry. The data of the field research was analyzed by SPSS and different tests

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were used, for example the chi-square test and the ANOVA - test. In the analysis and conclusion relationships with the conceptual model can be drawn, as it is all in line with each other. The analysis is further substantiated in the discussion and conclusion. The following conclusions were drawn:

Opportunity screening

• It has already been established that finance is the greatest problem regarding purchasing a horse, but now it has also been confirmed that it is the most limiting factor regarding the ambition of the athletes.

• The attractive horse market and the resistant attitude of the financial service providers against the dynamic movement of the athletes and entrepreneurs, make room for a new concept, namely leasing.

• Despite the low profit margins in the horse market there are financial opportunities for leasing.

The investor does not earn back the money in a short period, but the waiting can be

worthwhile, as the horse can be sold for an enormous amount at the end. In general, there are money making characteristics.

• The value-added potential is based on attracting clients on a broad perspective in a reluctant market of other financial institutions. However, the future lessees prefer, in the first instance, to buy with own resources rather than to lease.

Lessee perspective

• The preferred lease type of the lessees is operational leasing. The reasons for leasing are based on (1) risk reduction factors, (2) general advantages, and (3) financial advantages. In addition, the start-up companies are more influenced by risk reduction factors than the athletes.

Lessor perspective

• The lessor prefers operational leasing when it concerns offering a service. The most magnificent result of the research is that the potential lessees are interested in the leasing concept. The lessor must adapt a broader focus especially when it concerns the appropriate segment, as both athletes and entrepreneurs are interested. However, entrepreneurs offer a few more advantages. The investment will not collapse because of the suitability of the product, it is therefore riskless and innovative (type of service). The leasing company will always compete with people which prefer buying above leasing. However, lending does not offer the same amount of facilities and options as leasing does.

With these remarks in mind, it can be concluded that this idea is not only presentable but definitely also an opportunity for the lessee and lessor. It fills a gap in the market (financing of sport horses) and it has money making characteristics. On the whole, the answer to the main research question is positive.

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1. Introduction 1.1 Motivation

f you get rich from horses, you will never be poor” and “people with horses experience heaven on earth, but when they die, there is nothing to inherit.” The above mentioned Dutch expressions explain that keeping horses cost a lot of money. However, a lot of money circulates in this industry which offers opportunities (Inventarisatie en analyse

Paardenbeleid, 2008). The main aim for this study is to develop a lease construction (arranging money) for funding high quality sport horses (new opportunity).

According to the Ministry of Agriculture, Nature Management and Fisheries 2006, the sales in the horse industry have more than doubled to around € 1.25 billion (1990-2004). Research done by the Royal Dutch Equestrian Federation (KNHS) shows that the number of active equestrian athletes over the past five years (2001-2006) has increased by approximately 16 % (from 392,000 to 456,000). The sector has become professionalized and is ready for investment. In the Netherlands there are enough talented equestrians with the goal to achieve the top in the (professional) sport, but many of them miss the resources to invest in a quality horse which has all the Olympic qualities. They have to wait until they are discovered by either a talent program or wealthy businessmen. However, to accomplish this first step, the equestrians need a quality horse. Most investors such as a bank, do not like the idea that the borrowed money is deployed for creating a name and sport reputation, because the risks are too high and the rewards too low. So, a start in the horse business begins with differentiating options like trade, educating young horses or breeding. However, the top equestrians of the Netherlands are only focused on their main priority, sport.

A lease car will depreciate in a few years, the opposite is true with a horse in training, and this can result in attractive profits. Apart from the first argument, good quality horses are also very suitable for export to the USA or other foreign countries. A lease-investor will receive interest payments and also partake in the rising value of the horse while the equestrian develops a reputation with less financial risks, a classical win-win situation.

“I

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1.2 Relevance

During my internet-research I have discovered that the lease option in the horse industry is inaccurate.

A few farmers or riding schools give people the chance to lease a horse with normal qualifications.

However, in my opinion this is a form of rent, because the horses remain with the owner and they do not mention the option of buying the horse (no full legal and economic ownership). Mr. Franken of the Dutch Riding Horses and Pony Studbook (NRPS 2010) agrees with this argument. Often the

entrepreneurs do not know enough about leasing. They rent the horse instead of leasing it.

Furthermore, despite the economic crisis the prices of quality horses remain high and it is well known that banks are reluctant to lend money (Hunter, 2009). In general, during these times of economic pressures, people do not want to run the risk of certain expenses, and this is the reason why leasing is the perfect option. In times of chaos, ideas like this can result in an attractive opportunity.

1.3 The challenge of the research question

In this section, the purpose of the study is further detailed in a research objective, problem definition and research questions. The motivation for this research is the increasing interest in the equestrian sport. A consequence of this growth process is that the supply and demand of quality horses are driven apart. Prices of quality horses are very high and not attainable by the middle class of the population.

The basis of this study was to investigate whether a lease-option with reference to a quality horse would be an interesting financial option for the lessee and lessor. The ultimate goal will be launching the new opportunity on the market. This will contribute to a new funding method in the equestrian world. The research question is as follows:

“Is a quality horse a suitable lease investment for the lessor and the lessee and which lease construction should be developed?”.

The sub-questions will supply answers to the research question. The sub-questions are divided into three parts: opportunity screening, leasing regarding the lessor, leasing regarding the lessee.

1. Opportunity screening

• What is opportunity screening ?

• Which variables can be qualified regarding opportunity screening ?

• Is the idea in this research really an opportunity?

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2.a. Leasing from the perspective of the lessee

• What is leasing?

• What are the general characteristics of leasing?

• What kind of lease constructions are there?

• Which factors influence the lessees decision regarding leasing?

• Are the potential lessees interested in the lease option?

2.b. Leasing from the perspective of the lessor

• How do the lease constructions apply to the lessor?

• Which market segment is most interesting for the lessor ?

• Which financial lease consequences are there for the lessor?

• Is a horse a suitable lease product?

• Is the horse trader interested in the lease option?

1.4 Research design

This paragraph describes the research types and data resources. Two fundamental phases of research are treated in this research design namely the descriptive and explorative phases. Furthermore, these phases are developed by both desk and field research.

Desk research

Desk research is the systematic collecting and analyzing of available public information about competitors and developments regarding the market (Armstrong, 2007). The techniques vary from interviewing employees, surfing on the internet or, for example, observing competitors. The goal is to improve the strategic decision process and to discover opportunities in an early phase.

Through desk research, more information about the descriptive phase regarding leasing and the horse market was collected whereby a framework and conceptual model could be developed. Furthermore, the internet, academic literature and business documents contributed the most relevant data for this part of the research. The business documents gave a clear practical view of what is already known about leasing in companies and the facts of the horse industry. The business documents consist of presentations, previous market research and databases.

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Field research

Empirical scientist often use field research: a style of investigation that is also referred to as

‘fieldwork’, ‘qualitative methods’ or ‘interpretative research’ (Burgess, 1989). Field research is learning by which researchers have to understand the activities and behavior of the people they are studying.

The explorative phase begins with literature research (desk research), but research questions often stay unanswered and therefore second phase field work is also necessary (Cooper, et al., 2006). The field work phase contributes to the recognition of patterns regarding consumer behavior. The survey and personal interviews supplied the data sources. The field research consisted of two investigations:

• Firstly, 40 students of Helicon Training NHB Deurne (Horse sport education) were

interviewed regarding their perceptions of leasing in relation to horse sport. As they have the potential and possibility to work in the horse industry, start their own business and serve as (top-) athletes, their opinions create a good image of the potential lessees we would like to attract (screening consumer behavior).

• Secondly, two in-depth surveys were held amongst successful entrepreneurs in the horse industry. Their market experience was utilized for the horse consumers, competitors and dynamic environment.

The research design was only a short introduction regarding the types of research done. However, the methods, samples and data analysis will be further discussed in Chapter 6, Methodology.

1.5 Thesis structure

The thesis is structured as follows: Chapter 2, examines the opportunity screening. First the terminology regarding opportunity, idea and opportunity screening are reviewed. Thereafter, the criteria for screening an opportunity are discussed, and the criteria of Timmons (2009) is explored in more detail, as several criteria were used during the field research. In Chapter 3 the lease concept is examined. The introduction is based on general information about leasing for both parties, the lessee and the lessor. The introduction consists of definitions, general characteristics and developments of leasing. The Chapter continues with the perspective of the lessee regarding leasing and discusses the different lease types: financial and operational. With the help of textual examples the differences are highlighted even more. The reasons for the lessee and the legal aspect of leasing are discussed at the end. In Chapter 4, the lease perspective of the lessor is described. First the lease types and the lease segments are reviewed. The lease segments are divided into a segment of entrepreneurs and

consumers. Furthermore the suitability of the horse as a lease object is discussed and several criteria is given whereby this variable will be tested. At the end the financial consequences for the lessor, based

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on tax and financial facts are discussed. In Chapter 5, the conceptual model and its relations are proposed. The model is based on the theory which is discussed in the three Chapters regarding opportunity screening, the perspective of the lessee and lessor. After presenting the model the model proposal and the hypothesis are discussed. Chapter 6 describes the methodology. It starts with explaining the methods and sample size. Two types of methods were used, the experience survey and personal interviews. Furthermore, the measures are proposed and the data analysis explains the

research methods which have been tested with the program SPSS. Chapter 7, starts with the results of the research regarding opportunity screening. The three screening characteristics: equestrian market, economics and harvest issues give a clear image of the perspectives in the horse market. It also presents the analysis of the mentioned hypotheses. The first part of the Chapter provides the general facts of the interview results: sex, age, sport discipline and level. After the introduction each hypothesis is discussed on the basis of the SPPS-output. In Chapter 8, the results are discussed in more detail and verified by relevant literature. Limitations of the research and suggestions for a follow-up study are also mentioned. This Chapter ends with a conclusion regarding the main research question. In Chapter 9, the reflection is presented.

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2.1 The opportunity

The aim of this Chapter is to present criteria which Before starting this process, it is important to know An opportunity is an element of a broader perspective

Figure 1: Entrepreneurial process (Timmons, 2009).

Entrepreneurial process

Entrepreneurship is a way of thinking, reasoning and acting that is opportunity obsessed for the purpose of value creation and capture (Timmons, 2009). This description explains the entrepreneurial process. The Timmons model supports the research by indicating that the entrepreneurial process starts with the opportunity (the heart of the process). The

central, followed by the will and initiative to seize these opportunities. However, it all has to be in balance with the team and the resources.

Dollinger (1999), describes the first step regarding entrepr identification of resources. This corresponds

overlaps with the aspect “team”, because a resource is controlled if the team and entrepreneur have legal and physical access to it. Overall, the resources need to be identified, classified (control) and then the strengths and weaknesses are

substitutable?

Sustainability: for environment, community and society

2. Opportunity screening

is to present criteria which can be used to screen a new opportunity

ss, it is important to know the difference between an opportunity and an idea.

an element of a broader perspective, namely the entrepreneurial process.

Founder

: Entrepreneurial process (Timmons, 2009).

Entrepreneurship is a way of thinking, reasoning and acting that is opportunity obsessed for the purpose of value creation and capture (Timmons, 2009). This description explains the entrepreneurial process. The Timmons model supports the research by indicating that the entrepreneurial process starts with the opportunity (the heart of the process). The creation and/or recognition of opportunities are central, followed by the will and initiative to seize these opportunities. However, it all has to be in balance with the team and the resources.

the first step regarding entrepreneurial opportunity assessment

corresponds with the second step in the Timmons model, however it

“team”, because a resource is controlled if the team and entrepreneur have access to it. Overall, the resources need to be identified, classified (control) and then the strengths and weaknesses are to be indicated. Is the resource rare, valuable, hard to copy or non

Sustainability: for environment, community and society

opportunity venture.

portunity and an idea.

, namely the entrepreneurial process.

Entrepreneurship is a way of thinking, reasoning and acting that is opportunity obsessed for the purpose of value creation and capture (Timmons, 2009). This description explains the entrepreneurial process. The Timmons model supports the research by indicating that the entrepreneurial process starts

creation and/or recognition of opportunities are central, followed by the will and initiative to seize these opportunities. However, it all has to be in

eneurial opportunity assessment as with the second step in the Timmons model, however it

“team”, because a resource is controlled if the team and entrepreneur have access to it. Overall, the resources need to be identified, classified (control) and then

indicated. Is the resource rare, valuable, hard to copy or non- Sustainability: for environment, community and society

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Investor Arthur Rock said, “if you can find good people (team), they can always change the product”.

A good team supports growth and the survival of the business. Investor Rock only picked wrong people, not wrong ideas (Timmons, 2009). This short introduction of the process is important, because an opportunity is related to many other factors.

Idea or opportunity

An opportunity may be the chance to meet a need on the market through a creative combination of resources to deliver superior value (Ardichvili et al, 2000). An idea becomes an opportunity when it creates value to a customer, it solves a pain point (problem), it has money making characteristics and last but not least there is a good fit / risk balance between the whole team (Timmons et al., 2009). This description indicates that only some ideas become opportunities. Besides that, the imperfect market also influences the chance for more opportunities (Timmons et al., 2009). The characteristics discussed in this paragraph give options whereby the sub-research question, “Is this idea really an opportunity?” can eventually be answered. This question will be answered in Chapter 9.

2.2 Opportunity screening

This paragraph informs the reader about an overview of various screening criteria. Authors like Kumar, Macmillan, Siegel, Timmons and Spinneli investigated the different criteria and an overview of their results is presented. Their results led to an answer on the third sub-research question: “which variables can be qualified regarding opportunity screening?”. This paragraph will also give answer to the sub-research question: “what is opportunity screening?”. The Chapter ends with a summary of the Timmons and Spinneli criteria which were used in the analysis of the research.

Opportunity screening

The process of opportunity screening starts with the opportunity focus. Opportunity focus is developed through years of experience in businesses and markets. The outcome of these experiences have developed rules which guide them in screening a new chance. The venture screening process is a simple but highly skillful activity in which venture capitalists quickly gauge the potential of a business plan based on certain criteria (Kumar, 2003). Moreover, opportunity screening helps to identify successful venture teams and evaluates the attributes that distinguishes the successful firms from the unsuccessful ones (Timmons et al., 2009). According to Hall and Hofner (Kumar, 2003), venture capitalist screen an opportunity in six minutes and the whole decision-making process takes 21 minutes.

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Criteria

Firstly, the criteria in the screening process are not the exclusive domain of the venture capitalist as they are based on a good sense of great entrepreneurship. Secondly, they contribute to judgments about industry, the market, competitive advantage and management issues. For example a dominant strength in one of the criteria can result into a successful start of new businesses, whereas a flaw can be fatal to anyone. In the research of Kumar (2003), a review of opportunity screening criteria is summarized. Different authors state their opinion about the best indicators for screening an opportunity.

Table 1: Literature review from the research of Kumar, 2003.

In the article by Macmillan and Siegel (1985), five of the top ten most important criteria were concerned with the personality or the experience of the entrepreneur. There is no question that irrespective of the horse (product), the horse race (market), or odds (financial criteria), it is the jockey (entrepreneur) who fundamentally determines whether the venture capitalist will place a bet or not.

The critical market requirement is a high growth rate of the product. However, personality and experience (is the jockey able to ride the horse?) dominate the economic criteria, which are more important than product or market criteria. Moreover, the financial criteria, “a return of ten times in ten years” is very crucial. 84% of the venture capitalist reject the proposal when the entrepreneur cannot realize this condition.

Study Summary findings

Tyebjee and Bruno (1984) Venture capitalist’s decision criteria include market attractiveness, product differentiation, managerial capabilities, environmental threat, and cash-out potential

Macmillan, Zemann ,Narsimha (1987) Management staying power and familiarity with market were judged as the most important characteristics of a successful venture

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Ten most important criteria (Macmillan, Siegel)

1.Capable of sustained intense effort 64%

2.Thoroughly familiar with market 62%

3.At least ten times return in 5-10 years 50%

4.Demonstrated leadership in past 50%

5.Evaluates and reacts to risk well 48%

6.Investment can be made liquid 44%

7.Significant market growth 43%

8.Track record relevant to venture 37%

9.Articulates venture well 31%

10.Proprietary protection 29%

Table 2: Ten most important criteria (Macmillan, 1985).

Macmillan and Siegel identified the most important criteria which will be used by the venture capitalist. They concluded their research with important factors that were used to avert risk, such as management risk, product risk, viability risk, and liquidity risk (Kumar, 2003). Timmons and Spinneli (2009) formulated seven pillars for screening the opportunity venture. Some overlap with the research of Kumar (2003) and Macmilland and Siegel (1984). They all include the important impact of the personal criteria (management), the market attractiveness and the economic factors. Timmons and Spinneli expanded their list with harvest issues, strategic differentiation and competitive advantage issues. The table and the next section explain the criteria on a deeper level.

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Criteria for evaluating venture opportunities (Timmons, Spinneli)

Industry and market Market:

Customers

User benefits

Value added

Product life Market structure Market size Growth rate Market capacity

Market share attainable (year 5) Cost structure

Economics

Time to breakeven / positive cash flow

ROI potential

Capital requirements

Internal rate of return

Free cash flow characteristics Sales growth

Asset intensity

Spontaneous working capital R&D/capital expenditures Gross margins

After-tax profits

Time to break-even profit and loss

Harvest issue

Value-added potential

Valuation multiples and comparables

Exit mechanism and

comparables

Capital market context

Strategic differentiation

Degree of fit

Team

Service management

Timing

Technology

Flexibility

Opportunity orientation

Pricing

Distribution channels

Room for error

Competitive advantage issues

Fixed and variable costs

Control over costs, prices, and distribution

Barriers to entry:

- Proprietary protection - Response / lead

time

- Legal, contractual advantage - Contracts and

networks - key people

Management team

Entrepreneurial team

Industry and technical experience

Integrity

Intellectual honesty

Personal Criteria

Goals and fit

Upside / downside issues

Opportunity costs

Desirability

Risk/reward tolerance

Table 3: Criteria for evaluating venture opportunities

Three of the seven criteria (market, harvest issues and economics) were investigated during the field research. These criteria are decisive for the first screening phase (is there a market for sport horse leasing?), and in a follow-up study the personal criteria are discussed.

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2.2.1 Industry and market

Identifying a market niche for a business idea provides value to the buyers in today’s markets.

Furthermore, investigating loyalties to other brands or if the payback time to the investors is more than three years seems like an unattractive idea. Figures regarding market structure, market size, growth rates and market shares are important in analyzing a market. A potential investor wants information about the number of sellers, condition of entry and exit and sensitivity of demand. Perfect competitive markets with a high concentration of firms are unattractive for launching new

opportunities. A market size of 100 million offers opportunities, because there is a possibility to reach a sale of 5% without interrupting competitors. A firm that will capture less than 5% market share is unattractive in the eyes of a venture capitalist (Timmons et al., 2009).

2.2.2 Economics

Opportunities with a high potential gain a profit of 10 - 15% after taxes and within two years the business cash inflows are equal to the cash outflows. It sounds like much, however excellent investments usually yield a return of 25% or more. When the need for financial loans and funds are too high it is, in most situations, an unattractive deal. Most of those businesses will not survive for longer than 3 years. The decision making process for accepting or rejecting projects focuses on capital budgeting (Ross and Westerfield, 2008). The Net Present Value (NPV) is the last step in making the decision regarding capital investment. With the NPV method the stakeholder can calculate the rate of return on the investment and estimate the obtained discount rate. Is the discount rate enough compared to the risk to invest in leasing or is saving the money a better investment? The Net Present Value (NPV) is the difference between the sum of the present values of the project’s future cash flows and the initial cost of the investment. All the contributions by means of project to a firm’s value is simply the NPV of the project (value additive). The NPV is accepted when the project outcome is greater than zero. The discount rate on a risky project is the return that one can accept to earn on a financial asset of comparable risk.

The tree attributes for calculating the NPV:

NPV uses cash flows;

NPV uses all the cash flows of the project;

NPV discounts the cash flows properly.

A popular alternative to the NPV is the payback method. All investments that have a payback period of two years or less are accepted, and those that pay off in three or more years are rejected. The internal rate gives information about the risk-reward relationship of the investment.

Cash flow operations NPV = - investment + _________________

Discount rate

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2.2.3 Harvest Issues

Contractual rights, geographic coverage or customer base can provide high strategic value. These characteristics contribute to a much higher sale. Companies with many financial obligations and operations in uncertain environments, are less attractive for risk averse investors. The entrepreneur should have a harvest objective in mind and planning is a critical point. Opportunities with less potential do not have an exit mechanism, however this should be calculated in the whole strategic value process. When debt is available against reasonable or good rates new businesses will start as it is all about the timing element (Timmons et al., 2009)

2.2.4 Competitive advantage issues

A competitive position can be created by low-cost production, low cost marketing and distribution cost, which will eventually enlarge the lifecycle of the product. Control in the market would give a market player a dominant market position even if the other areas are weak. However, if the dominant market player is not innovating and slow in adding capacity, there will be opportunities for new entrants. If a market is dominated by a competitor with 40% market share, it will have an impact on the freedom in choice for customers, suppliers and new entrants. Creating advantages ( legal, contractual, networks, key people) can cause entry barriers for others (Timmons et al., 2009).

2.2.5 Management team issues

Launching an opportunity is not possible without a good team, as already mentioned in the

entrepreneurial process. In some industries the team is the most important element, for example in technical industries by means of their reputation. Integrity and intellectual honesty are the basic elements for the entrepreneur and his reputation (Timmons et al., 2009).

2.2.6 Personal criteria

Is there a good balance between the success of the business and the happiness of the entrepreneur?

Before starting a firm, an entrepreneur should consider the disadvantages and advantages of having a business. The goal of the entrepreneur has to match with the lifestyle he or she wants to live. In some situations a firm should expand abroad, however some business people do not have this ambition and want to work in the local sector (Timmons et al., 2009).

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2.2.7 Strategic differentiation

There must be a good balance between the driving forces which include opportunities, resources and a team. Adapting new strategies if the market or environment changes is necessary for the growth and sustainability of a firm. Timmons (2009) states that 15% of the customers will not buy new products of a firm due to insufficient quality of the product or services and 70% due to insufficient customer service. A breakthrough in technology can result in a highly competitive advantage. To change a firm’s culture takes between 10 and 20 years, but changing a firm’s strategy takes approximately six years (Timmons et al., 2009).

Conclusion

The entrepreneurial process is driven by opportunities. “Opportunities” can be distinguished from

“ideas” by means of screening the criteria which are characteristic of successful firms. Many authors have written about these criteria such as market facts, economical ratio’s, harvest issues and personal criteria. According to all the authors, a business concept can not be rated without the personal, market and economic criteria. The goal of opportunity screening is to distinguish the successful business concepts from the unsuccessful ones.

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3. Leasing

This Chapter starts with the introduction where the meaning of leasing, it’s characteristics (sub- research question) and developments are discussed. The introduction is applicable to the lessee and the lessor. The next section is more applicable to the lessee and will introduce the two types of leasing as well as the reasons for leasing.

3.1 Introduction

Since ancient times it has been possible for the owner of a product to lend it to a third party, without giving it away or losing the legal title. Separation between ownership and the use in the leasing concept is not unique when we consider renting. However, what makes it unique stems from the length of the lease contract and the economic life of the object.

Lease

Leasing is defined as a contractual arrangement for trading the right to temporary use of an object, but not the rights to all possible future uses (Flath,1980).

According to Bandsma (1990), leasing is a collective name for transactions relating to the operation and use of movable an immovable (business) resources. The use of these lease-objects is based on

contracts which is in any way derived from the economic life of the object.

"A lease contract is a contract whereby one party gives away the right of use of a lease-object for an agreed period and for a certain compensation to the other party (Dirksen, 2009). "

The formulated definitions emphasize the economic ownership and right of use regarding leasing. The practical side is clearly highlighted in the definitions showing that there is an agreement between two parties which involve performances (use product) from the supplier and the consumer. The definitions further highlights that the concept of leasing is based on the economic life of the assets and that the economic reality of leasing is of great importance. Two main parties are involved in the leasing process: the lessor (the leasing company who makes the products available) and the lessee (consumer of the lease product). This Chapter concentrates more on the lessee and Chapter four on the lessor.

In my opinion the definitions of Flath (1980) and Dirsken (2009) are not complete as their definitions do not show a clear distinction from renting. It is also important to mention that even though the legal ownership stays with the lessor until all payments have been settled, the lessee can act as the

economic owner. Furthermore, I would like to emphasize one element of the definition of Bandsma (1990), namely that the lease use is based on the economic life of the object and by this it is distinguished from other transaction forms related to the operation of resources.

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3.2 The general characteristics of leasing

This paragraph answers the sub-research question, what are the general characteristics of leasing? In order to clearly understand the phenomenon of leasing the following basic characteristics have to be explained: the use of the object, the independent economic value of the object, the role of the lessee in the investment decision, the relationship between the economic life of the object and the lease time and finally the risk reduction regarding leasing.

The use of the object is central.

With leasing the use of the object is central in that it creates a right to use the product. The right of use and ownership are in different hands. For the lessee the use of the asset regarding the profit of the business is more important than the ownership. However, the lessor is therefore not necessarily always the owner. Various forms of ownership are possible, sometimes the lessor does not have the

ownership, but only the right to security (Joosen,1990).

Independent economic value of the object.

The differences between leasing objects can be perceived when we look at the following examples of leasing objects which include cars, computers, airplanes, shops, copiers, earthmoving equipment and mobile cranes. These examples can be divided into movable and immovable (business) resources and the distinction between these two is determined by the lease arrangements in the contracts. That a lease object must have value, can be derived from the fact that leasing objects have an economic life. It is important that the object remains available (not merge into a bigger picture), so that the economic value remains unaffected (Joosen,1990).

The lessee plays an essential role in the investment decision.

Depending on the lease, the lessee selects the object and the lessor is, in some cases, an intermediary and will only give advise were necessary. The lessor is also the contact person if there are

improvements to be made. Generally, the lessor is the derivative investor. The lessor will arrange stronger standards for financial settlements, when the value of the object decreases (Schallheim, 1994).

The relationship between the useful economic life of the object and the time of the lease contract.

The term of the lease depends on the economic life of the product but the contract can not be cancelled. The economic life of the product consists of the optimal use of the product and in most cases the useful economic life of the product is also the optimal life time of the product, with a positive financial return during this period. If the duration of the contract is a part of the economic life, the appropriate residual value is allocated to the product. The economic value is estimated by the parties after having taking all the relevant factors (the market, the age of the product) into account.

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Risk distribution regarding leasing

The economic risk between the lessor and lessee can be divided into an owner’s risk and user’s risk.

The user’s risk will be contracted to the user and the owner’s risk will be divided. The risk regarding not meeting the requirements is allocated to the lessee and the risks regarding the technical functioning will be divided among the parties. The lessor will rarely carry all the owner risks. The lessor can share the residual value risk with one or more lessors, also known as syndicate-leasing (Joosen, 1990).

3.3 Lease developments in the Netherlands

Opportunities for the Dutch market

Despite the economic crisis (beginning) the performances of the Dutch lease-industry were high in 2007 with a 24% production increase to a level of over 6.1 billion Euros. In July 2007, Mr. Linders stated that (Deiters, 2007), “in 2008 the production remained the same”. This favorable line is the cause of the Basel-II law. This law has turned out well for the leasing market, because leasing is not qualified as a distinctive product when compared to other forms of credit.

Dutch entrepreneurs

Mr. Linders, director of the lease company Amstel, informed us that Dutch entrepreneurs finance their business assets too conservatively as 25% of the Dutch entrepreneurs choose their own financial resources. This has caused an image whereby leasing is seen as too expensive. However, in foreign countries the lease of business assets is a more important issue. In Great Britain for example 20% of business assets are leased compared with the 7% in the Netherlands. According to Mr. Linders:

“everything is leasable” (Deiters, 2007).

Distribution channels for leasing

The most important channel for selling lease products is by means of financial institutions and in 2006 and 2007 it comprised 75% of the total production (NVL, 2007). The products are mainly sold to small and medium enterprises. The direct sales by individual lease agents is decreasing (13%, 2008).

However, it remains an extremely important form of approaching the market (NVL annual report,2008). The competition in the leasing market is strong due to the price differentiation and competition for better customers and better products are increasing. An investigation done by the marketing research of TNS-NIPO in 2008 shows that 6% of the non-leasers will start leasing in 2009.

The potential lease investors consist of huge companies which are better informed of the advantages regarding leasing and can estimate lower risks. The general knowledge regarding leasing is low which makes the product less popular. The search machines on the internet are the most important source of information regarding leasing.

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2007 (x euro, 1million) 2008 (x euro, 1 million) Agricultural, forestry,

fisheries

263 349 133 %

Industry, construction 1134 1091 96%

Private services 3984 4030 101%

Public services 232 231 100%

Other / unspecified 489 580 119%

Total general 6.101 6.281 103%

Table 4: Turnover in the lease market in different sectors (NVL, 2007):

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Leasing in the perspective of the lessee

3.4 Types of leasing

The following paragraph will answer the sub-research question: what kind of lease constructions are there? All the lease variants can be reduced to two main forms: operational leasing and financial leasing. There are many differences between these two options regarding the terms of the contract, the ownership of the product and which party runs the economic risk. The characteristics and differences are explained in the next paragraph.

3.4.1 Financial leasing

This paragraph begins with an illustration concerning financial leasing.

Financial lease or net lease are based on lease payments that repay the full costs of the asset and the lessee pays all property taxes, sales taxes, maintenance and insurance (Schallheim, 1994). This definition is strong because it uses two expressions (words) for the same explanation. In my opinion the term net lease is stronger, because the message is hidden in the name. Net lease already suggests that all the costs are reduced from the gross expenses and this is the punch line and the main difference with operational lease. However, as financial leasing is more well known this term will be maintained.

The basis for financial leasing is financing. The lease period is (almost) the same as the economic life of the product. In some cases the purchase price inclusive of the sales taxes or VAT (in Dutch: BTW) is financed for the lessee. This is a financial benefit for the lessee, because the sales tax is not

deductible. The terms of the contract are based on the economic durability of the asset and the contract can not be terminated. After the contract the lessee will get the legal and economic ownership

(Joosen,1990). With financial leasing the lessee bears the economic risk because after the lease period the lessee gets the property (usually) automatically into his/her possession. He has the benefit of any

Example A:

A lessee would like to invest in a new drawing-table for the architectural department (100.000 euro). The lessee makes an arrangement with the lease company. The lease company buys the equipment and offers a lease period of 62 months. The lessee pays a monthly amount of 2095 euro. At the end of the 62 months a total amount of 129.890 euro was paid to the lessor. In the contract it was arranged that after the terms were paid in full, the lessee receives full ownerships.

The lessee bears the economic risk of the product. At the beginning the product existed on the balance sheet of the lessee.

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appreciation or depreciation of value. The fact that the lessee bears the economic risk leads to accounting consequences as the asset is activated on the balance sheet of the lessee. Financial leasing is chosen by lessees because of the 100% financing of the asset and the remaining money can be used for other purposes. The financial guarantee for the lessor is limited by means of the leased product, so the remaining products can be used for other financial goals. Another benefit is the fixed prices of the lease terms which gives the lessees a better overview concerning their profits and expenses. The advantages are more extensively discussed in paragraph 3.5.

3.4.2 Operational leasing

This paragraph starts with an illustration concerning operational leasing.

Operational leasing does not have an exact definition, but accountants formulate it as leases that are not required to appear on the balance sheet (Schallheim,1994). This definition is not accurate for this research, because the Accountant Standard Board (IASB) are currently in the process of developing a new standard for international lease accounting. However, this point of view is mentioned in this research because the old situation had a big impact on the leasing industry. The new approach differs substantially from today’s standards which is based on an analysis of the risks and rewards inherent to the lease. I will now try to explain this complicated matter. A lessee would always recognize an asset, the right to use the leased item and a corresponding liability on its balance sheet. However under the current standard a lessee recognizes the leased asset only under so-called finance leases (because it is visible on the balance sheet). There is no difference anymore between operational leasing and financial leasing on this point. One of the results of this change is that putting leases on the balance sheet will increase the post capital requirements (leaseurope, 2008).

Example A:

An accountancy office would like to lease cars for their external advisers.

They would like to do this for a period of 40 months. The lessee pays for a new Volkswagen: 500 euro per month. After 40 months the lessee paid 20.000 euro. However the new car cost 30.000 euro.

After the 40 months the car goes back to the lease company. The lease company has not covered the 30.000 euro of the total investment. The lease company will then try to sell the car for at least 10.000 euro to cover the whole investment. It could be that the company makes a profit or a loss. In most cases a buy-option for the lessee is included in the contract.

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The lessee is not responsible for the maintenance, insurance and depreciation of the product. In most cases the lessee gets the right to buy the product at the end of the contract period for a previously discussed price. When this value is not that promising after all or it overlaps with the market value then the lessee will waive this right. The basis for operational leasing is the possibility of making temporary use of a business asset. This fact contributes to several reasons why business people choose for operational leasing. These reasons are, firstly, the lessee will not have the economic risk and does not have to invest in the product. Secondly, when the lessee has a buy-option included in the contract, he/she has the option to make the choice after the end of the term. With these arrangements the lessees can make the best financial decision for the business. In the next paragraph the advantages are

discussed in more detail.

3.5 Reasons for leasing

In this paragraph the lease advantages from the perspective of the lessee are introduced. Five advantages will be discussed: general, tax savings, risk sharing, financial and transaction and information advantages. Schallheim (1994) clearly formulates the essence of leasing:

“Equipment leasing provides customized financing with potentially unique tax features”.

This definition formulates a clear image of lease advantages. It does not only finance a product but it is done with a customized perspective. Service is also a general advantage of leasing. Furthermore, the financial opportunities are also based on the element of tax. The motives mentioned below will play an important role in the decision-making process for lessees:

Table 5: Reasons for leasing (self-created table using the literature discussed below).

Reasons for leasing:

• General advantages regarding leasing

• Transaction and information

• Tax savings • Risk sharing

• Financial

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3.5.1 General advantages regarding leasing

The lease concept in general also gives a few advantages that need to be mentioned. Firstly, lessees are able to re-invest quicker in new material (obsolescence risk) because of the short term asset use and the fact that their own resources are not affected. Secondly, leasing makes all costs public and there are no surprises as all the costs and fixed payments are known. In addition, flexible arrangements regarding lease terms with lessors are possible. This is a form of service which is not known with every financial institution as the restrictions with a loan from the bank are usually not that flexible.

Thirdly, expanding the business by means of leasing is quite flexible (Coolwijk, 1989), also because of the flexible lease restrictions and the own resources that can be captured. It will be mentioned a few times in this Chapter that leasing reduces certain types of uncertainties (Ross and Westerfield, 2008).

This will be discussed in more detail in paragraph 3.5.5.

3.5.2 Tax savings

First the legal perspective of leasing will be introduced. This will give a clear view of the intention of the law regarding certain tax forms. Secondly, only a brief summary of the most important taxes will be given, otherwise the thesis will become too complex and detailed.

Legal

This paragraph explains the intention of the law regarding the income- and corporation tax. It is important to distinguish between operational and financial leasing. The main criteria responsible for this distinction is the element of ownership (legally or economically). However, in this research both lease options are briefly mentioned with attention paid to explaining the advantages and remarks. The basis for the decision regarding lease arrangements by the Secretary of State for Finances is based on the term ownership. It states that the owner behaves as an owner, possesses the legal ownership of the lease object and accepts the positive and/or negative residual value risk in respect of the lease object (lease arrangement, 2000). With the economic ownership of a product all the rights and obligations are transferred and the “getter” can indeed posses the product. The getter will be the juridical owner when he signs all the papers (notary). For the legal support in this paragraph the book from Geschriften van de vereniging voor Belastingwetenschappen (2001) (Documents of the Association for Tax Purposes) and the lease arrangement (2001) on the webpage of Nederlandse vereniging van leasemaatschappijen (Dutch Association of Lease Companies), have been used.

The lessee must be aware of the following:

1. The present value of the lease payments is at least 90% of the fair market value of the asset at the start of the lease. The term of lease must be less than 30 years.

2. The contract period of operational leasing will not be longer than 85% of the economic life of the product. The contract period of financial leasing must be at least 75% of the economic life

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Sales tax – delivery Investment Lessor:

New piano: € 20.000 Sales tax (19%) € 3.800 + Total investment € 23.800 The lessor will indirectly pay

€ 3.800 to the tax office. The lessor will calculate it in the first lease payment of the lessee.

The lessees first payment will be € 833 euro + € 3.800 (sales tax). The lessee can claim this back through a VAT-

declaration.

of the product. The law defines the economic life of a product as the estimated life in which the object can justifiably operate economically in the business of the lessee.

3. The option price for the lessee must be real. The amount of the purchase option or the present value of the renewal option amount is not less than 7.5% of the tax cost. The lease should not have an option to acquire the asset below its market value or the agreed price. Contracts without options regarding purchasing can not be sold for less than 7.5% of the tax cost.

4. The financial lessee must pay 90% or more of the start value of the lease object during the lease period. With financial leasing it is allowed to sell the object at a price lower than the expected fair value, provided it is in accordance with the foregoing rule.

The sales tax and corporate income tax are the two specific taxes which make a great difference for the entrepreneur. Important to know is that there should be a different tax rate in order for both the lessee and the lessor to gain anything. However, when there is no difference in tax rates for the lessor and lessee, then the lessee can make the choice for leasing based on the uncertainty about future earnings.

Finally, leasing offers advantages for small firms with low earnings and / or low tax rates.

Sales tax

Sales tax is a consumption tax calculated at the point of

purchase for certain products and services. The tax is formed as a percentage and is charged by the government (Dutch tax office, 2009). With sales taxes it is important to know if the leased goods are regarded as a delivery or a service. It is also possible that the lessor performs two options for the lessee, namely the supplying of goods (delivery) and the provision of credit (service). If the lessee has agreed to become the owner after the last payment, then it is considered a delivery. This is also the case if it is agreed that the lessee is the owner from the beginning. Sales tax must be paid by the lessee on the total amount of the lease payments and option price. The lessor can not claim back the sales tax with a VAT-declaration. However, when the lessee does not use the buy-option, then the lessor can claim back the sales tax. In conclusion: the first period of the lease term includes sales tax, until the lessee becomes the owner. If the lessee is an entrepreneur according to the law, than the lessee can claim back the sales tax . If the lessee is a private person than he/she can not claim back the tax.

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Sales tax – service Investment Lessor:

New piano: € 20.000 Sales tax (19%) € 3.800 + Total investment € 23.800 The lessor will indirectly pay € 3.800 to the tax office. The lessor can claim this back through a VAT- declaration. The lessor is the owner.

• Per month the lessor must pay sales tax of €158 (19%

of €833).

• With regards to the € 1400 interest component (7% of 20.000 euro), 266 euro must be paid.

With operational leasing the product is considered as rented or temporarily used. There is a service if the conditions of delivery are not met. If the lease is to be regarded as a service, the lessor must pay sales tax with every lease term (including the interest component). When the lessee wants to make use of the purchase option, then the lessor must pay sales taxes on the option price because of the delivery. At the moment 6%

sales tax is calculated on the horses in the Netherlands.

The European Commission started a procedure against the Netherlands because of the fact that they calculate 6% sales tax on sport horses. According to them The Netherlands hampers the free economic trade, because in other countries higher rates apply. It could be that 19% sales tax will be introduced in the future and this will have a great impact on the Dutch horse market (Sector raad paarden (SER), 2009).

Corporate income tax

Corporate tax means the tax that is levied by various jurisdictions on the profits made by businesses or associations. The tax is charged on the value of the corporation’s profits. Rates for 2009 are calculated as follow: more than zero but not higher than 200.000 euro is 20%, above that 25.5% is calculated (Dutch tax office, 2009). These percentages applies to public limited liability companies and private limited companies. The profit of partnership firms or a one-man firm are charged with income tax.

These tax rates vary from 33,45% till 52,00% but it depends on the amount of profit.

With corporate income tax the consequences concerning financial leasing are as follows (Duffhues, Groeneveld, 1997):

• the lessee is the economic owner and may depreciate the product on the balance sheet;

• the lessee is only allowed to deduct the interest component on the taxable income;

With corporate income tax the consequences concerning operational leasing are as follows:

• the lessee can not depreciate the product on the balance sheet;

• the lessee can deduct the whole amount during the lease term as costs.

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3.5.3 Financial advantages

There are a view financial reasons which influence the choice of leasing. These reasons save costs for the lessees. A reason to choose financial leasing is for example the 100% financing arrangement. The full cash or other profitability can be used for saving instead of investing. The mentioned arrangement concerning the off-balance financing is not treated as a motive for leasing because of the changing regulations mentioned earlier. A point which entrepreneurs obviously do not want to think about is the potential risk of bankruptcy. However, in financial distress and bankruptcy, a lease can have higher priority than other forms of debt. The lessor is able to repossess the assets with minimal costs and that is why small business owners still have the last option to lease while other financial institutions ignore them. Last but not least, leasing is a cheaper way of financing equipment (Schallheim, 1994). Another favorable fact is that it will hedge against inflation.

3.5.4 Transaction and information

Transaction and information costs are the costs regarding participating, consultation and meetings with customers, distributors and employees in the internal organization. If the lease payments include service agreements then transactions costs play a large role. Arranging contracts with all the parties results in transaction costs. The service with leasing are lower because separate maintenance contracts regarding a purchased product are more expensive than the collective arrangement of the lease

company (Schallheim, 1994).

3.5.5 Risk sharing

A large segment in the leasing business is formed by residual value risk or the avoidance of risk in general. Businesses do not want to have for example the technological risks of a computer network. In most cases the ownership of the leased products remains with the lease company. So, the lessee will not become the owner until after all the contracted payments have been settled. An advantage of not becoming the owner is not having the risks regarding the product. A lessee that does not want to have the residual value risk can transfer the risk to the lessor. Residual value is nothing more than a decline in the value of the assets at the end of the lease term and this value is below the lessor's expected value. Of course, the lessor will adjust the lease payments to cover this risk. Operational leasing also covers the risks concerning interest rates of bank debts and maintenance.

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Residual value is the wild card of leasing because huge profits or losses are occasioned on realization of the salvage value (Schallheim, 1994). The type of lease assets influence the lease payments entirely when the residual value is affected by obsolescence risk (technological innovations with computers).

The uncertainty of the residual value will be calculated in the lease payments. In a few cases the asset concerning the economic value will depreciate minimally. Furthermore, in some circumstances the market value is higher at the end of the lease than at the beginning. The factors that contribute to the residual value are periodic fluctuations in the market value of an asset (supply and demand,

technological obsolescence risk). The leasing company in this thesis will deal with residual risk that is specialized in one asset in order to maximize the residual value through expertise in the resale market.

The risk can be reduced for the lessor by means of diversification of several services / products.

Conclusion

Firstly, the lessor gives the right of use of a lease object away and the object is characterized by independent economic value. There is also a relationship between the economic life of the product and the lease term. Furthermore, the lessee plays an essential role in the investment decision and financial compensation for the lessor. Leasing consists of two lease types; operational and financial leasing. Operational leasing is based on using the asset for an agreed period, but not owning it at the end. However, the foundation of financial leasing is based on owning the product in the future. The reasons for the lessee when considering to lease are different and can include general advantages such as transaction and information advantages, financial- and tax advantages and risk sharing. In general, the lease market offers potential with the advantages, developments and lease options.

If you get rich

If you get rich

If you get rich from horses, you will never be poor……

(Dutch expression)

horses, you will never be poor……

Preface

Executive summary

Table of contents

1. Introduction 1.1 Motivation

“I

1.2 Relevance

1.3 The challenge of the research question

1.4 Research design

1.5 Thesis structure

2.1 The opportunity

2. Opportunity screening

2.2 Opportunity screening

3. Leasing

3.1 Introduction

3.2 The general characteristics of leasing

3.3 Lease developments in the Netherlands

Leasing in the perspective of the lessee

3.4 Types of leasing

3.5 Reasons for leasing