What is an equity participant in a leveraged lease?

The lessor is the equity participant, which is one or more parties in a leveraged lease that as owner of the leased asset holds beneficial interest in the asset and has the risk, rewards and full tax benefits of asset ownership.  The leveraged lease arose as a means for lessors to maximize the tax benefits associated with lease transactions while raising the debt capital (leverage) required to finance big-ticket assets.  The equity participant has the risk, rewards and full tax benefits of ownership, including any investment tax credit and income tax advantages, such as accelerated depreciation, in addition to the tax deductibility of the debt service costs.  The lessor shares the tax benefits of asset ownership with the lessee in the form of a lower financing cost compared to alternative forms of financing.

The equity portion is the funding in a leveraged lease that is provided by the equity participants ranging from 20% to 40% of the investment in the leased asset, it equaling the difference between the asset’s cost and the present value of the lease payments.  Despite the relatively small investment, the lessor is able to take full advantage of the tax benefits of asset ownership and depreciate the full cost of the asset for tax purposes.

The lessor receives the rental payments from the lessee and retains the difference between the MLPs and the debt service payments of principal and interest to the long-term creditors (debt participants) and receives the salvage value from the asset’s disposition at the end of the lease term.  The lessor’s early net cash inflow and return on the investment in a leveraged lease results from lease rentals and income tax benefits from the leased asset’s depreciation – often accelerated, interest expense on the debt and tax deduction of other expenses.  Generally, the net investment in the asset declines in the early years and rises during the final years of the lease.

Where there is more than one equity investor, an owner trust is generally required.  An owner trust is a grantor trust or partnership established to hold the leased asset for the benefit of two or more equity participants acting together as the lessor in a leveraged lease and to raise the required debt and equity capital.  It is structured for tax purposes either as a grantor trust or partnership, whereby income and tax deductions are declared on each investor’s income tax return.  An owner trustee, as agent of the equity participants in a leveraged lease, holds title to the leased asset and receives and distributes to the equity participants any surplus rental or other income that remains after payment of principal and interest received from the lessee is made to the debt participants.