Leasing
This type of financing involves two parties the lessor and the lessee. Under the leasing agreement, the lessor gives the right to the lessee to use a specific asset for a prescribed period against the payment of the lease rental. Being one of the simplest method of acquiring an asset based on the few formal transaction involved, the ship owner can opt to use this method in order to acquire the two ships. Another aspect which makes this method appropriate is the flexible repayment period. The ship owner who is the lessee in this case, can decide to pay for the lease rental on yearly, semiannually, quarterly or monthly basis. The lease contract is for a specific period for example 7 years, 10 years or 25 years (Gove et al, 1961). Depending with the period which the ship owner agrees with the lessor he will acquire the right to operate the vessel as long as he continues paying the lease rental as per the contract. Another advantage of leasing is that there is higher leverage for the lessee. This implies that the right to use the vessel is obtained by the lessee immediately the agreement is finalized. Even though the lessor retains the legal ownership of the vessels, it is advantageous to the ship owner in the sense that his business operations will continue to operate and the revenue generated will cater for the purchase cost of the ships. Similarly, the ship owner will benefit from the depreciation and the capital allowances which reduce the tax payable by the owner. As a result the ship owner will benefit from higher profits.
However, this method has some disadvantages. First, it is expensive in the short-term. It is prudent to note that in most cases the prices of vessels acquired through leasing are higher as compared to other methods of purchasing. In this regard, the ship owner will pay large amount of money in the form of instalments(Martin,2009). This makes this method costly for the ship owner which implies a large capital outlay during the initial stages of operations. Nevertheless, the ship owner can use this method based on the many advantages associated with leasing.
Bank loans
Commercial banks are other crucial financial institutions which can give loan to the ship owner in order to acquire the ships. As indicated earlier, the challenges faced by the companies or individual ship owners is due to the hesitant of some financial institution to give loans needed for purchasing second hand vessels such as the panamax dry bulk carriers. In this regard, the ship owner should seek loan from the commercial banks in order to purchase the vessels. The first advantage of borrowing from the commercial banks is that they are flexible and quickly react to the customers requirements and problems. This implies that the delays related with loan acquisition are eliminated which makes the ship owner to start his operations in a timely manner. Secondly, commercial banks offer personalized services. This means that more attention will be given to the ship owner regarding his preferred repayment period and the amount of the loan needed. Thirdly, commercial banks offer their loan at a lower cost as compared to other financial institutions. This will enable the ship owner to pay little amount of money as the interest on the loan, which is a fundamental aspect which will lead to the expansion of his business operations. In addition to the financial assistance that commercial banks offer they are at the forefront in giving advisory services to their customers. This aspect will be imperative for the ship owner which will help him to effectively utilize the loan and avoid diverting the loan to other personal use however much they will be urgent.
Lack of adequate collateral is one of the factors which can hinder the ship owner from accessing the loans from the commercial bank. In this regard, it is prudent that the ship owner considers seeking for finance from other sources such as the ship mortgage bonds.
Ship mortgage
This source of finance makes it possible to acquire finance by mortgaging the ships owned. Two parties are involved in this source of finance these are the mortgagee and the mortgagor. In this case the mortgagee is the finance company offering the loan while the mortgagor is the ship owner. The loans obtained by the mortgagor are to be repaid through installments over a specific period of time. One of the advantages of using this is that it is a long term source of finance used to acquire assets, buildings and ships. Secondly, the interest on mortgage is an allowable expense for tax purposes. Just like in the case of leasing as a source of finance, the mortgagor remains with the vessel which makes it a flexible source of finance. However, since the ship owner may not have more ships to mortgage, it may not be possible to utilize this source of finance.
Mezzanine finance
The mezzanine finance is another source through which the ship owner can get the funds. Also referred to as a junior debt, Mezzanine finance will give the ship owner an opportunity to bridge the gap which exists between the equity and the bank debt. One of the major advantages of this source of finance is that the investor will allocate fewer funds in order to acquire the loan. In addition, the ship owner will have more power over the vessel just like in the leasing. Similarly, due to the few legal arrangement involved between the loan seeker and the financial, this source of finance is not restrictive implying that the ship owner will be in a good position to acquire the funds needed to purchase the two ships. However, the high yield debt is an obstacle which may deter the ship owner from using the mezzanine finance.
Financial leasing
Financial lease is a lease that transfers substantially all the risks and rewards of ownership of an asset to a lessee. One of the aspects which make it appropriate for the ship owner to emulate this kind of source of finance is that it is non-cancellable and long term. This implies that there is no situation which may hinder the ship owner from owing the ships. Secondly, the lease paid by the lessee is allowable expenses for tax purposes. Thirdly, the ship owner can benefit from this method in that he will acquire the ships without incurring capital expenditure. Fourthly, if the ships are for commercial purposes the ship owner can cancel the contract if the business is not profitable. Due to the regular changes of level of technology in the shipping industry, this method of financing is also advantageous in that it is suitable for the assets which become obsolete very fast (John and Murphy, 1999).
The first major disadvantage of this source of finance is that the rental charges paid by the lessee may be too high. This would increase the business expenses leading to decreased profits. Secondly, the terms and conditions of financial leasing may not be favorable to the lessee and he may not be able to utilize the vessels conveniently. It is also a risky source of finance in that if the ship owner decides to purchase one ship first, the lessor may decide not to renew the contract. This implies that the ship owner may fail to acquire the two ships contrary to his intention.
Hire purchase
This is another method which can be applied by the ship owner to purchase the ships. Due to lack of adequate liquid cash by most of the companies, hire purchase has become the alternative option which has enabled organization acquire the assets which seem to be expensive. This method entails paying for the vessels out of income rather than capital. The use of the vessel will be gained on the on payment of the first instalment. Hire purchase has become increasingly vital in the contemporary business arena especially during acquisition of capital goods. The first advantage of this mode of financing is that the ships will be gained on payment of the first instalment. This means that the ship owner can use the vessels to generate profits which can be used to repay the succeeding instalments. Secondly, the instalments paid are predetermined. This avoids the seller from making any changes on the cost of the vessel. Thirdly, there is no collateral required in order to acquire the asset, as a result the large amount of capital is not tied up. Nevertheless, hire purchase may not be appropriate based on its three disadvantages. First, the instalments charged are high. This increases the entire buying price of the ships.
Secondly, due to unavoidable circumstances the ship owner may not be able to pay the instalments on time as a result the ships may be re-possessed by the seller. Thirdly, the ownership of the ships will remain with the hire purchase company. Based on this the ship owner may not effectively utilize the vessels (Thomas and Robert, 1982).
Differences of methods of funding for the ship owner, a well established ship owner with a current fleet of over 20 similar vessels and a small independent owner with only two such vessels in the present climate
Based on the above discussion on the various sources of funds available for the ship owner, a well established ship owner with 20 similar vessels will utilize different sources of funds. First, the well established ship owner might not access loans due to lack of trust by the financial institutions. As a result, he might opt to use other sources of funds such as the IPO (Initial Public Offer).However, this can only happen only if he owns a company (Joseph, 2000). In addition, the individual may come together with other companies in order to be more qualified for higher loans. By maintaining proper books of accounts and maintaining high credit worthiness, such an individual may utilize the services of companies such as Standard and Poor in order to undertake external credit worthiness rating which is required by most of the financial institutions when giving loans (Martin, 2009).
In the same way, a small independent ship owner with only two vessels will utilize different methods of finance. This is based on the fact that banks and other financial institutions are not flexible with small ship owners in the current climate. An independent ship owner may therefore seek for private debt from insurance companies or private equity which is commonly provided by hedge funds.
Basing on the above analyses it is precise that the large amount of capital required to purchase the ships can be addressed by use of various sources of finance. The most important thing is for the individuals and the companies to undertake an intensive study on the most profitable and economically viable source which will guarantee future positive returns. According to my perspective, I would advice the ship owner to go for commercial bank loans due to the flexibility associated with this source of finance.
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