4 Legitimate Uses of Off-Balance Sheet Financing

Off-balance sheet financing is a type of arrangement that many companies use to make their numbers on the balance sheet look better than they actually are. They will arrange it so that an off-balance sheet entity takes a good portion of a company's debt to improve financial ratios. Even though these entities have come under a lot of scrutiny lately, there are some legitimate uses of this type of account. Here are a few of the legitimate uses of off-balance sheet financing.

1. Pursue a Similar Business Opportunity

One of the legal uses of off-balance sheet financing is to pursue a similar business opportunity. In some cases, a company does not want to change anything about their current business, but they want to be able to branch out into a similar business venture to what they are currently involved in. If this is the case, they can set up off-balance sheet entities to pursue these goals. They can fund the smaller company and provide it with the resources that it needs to succeed. This is often done when a company does not want to dilute the shareholders. It also helps them avoid taking on excess debt that can change their financial ratios. By using a spin-off company off of the balance sheet, they can keep everything about their main company intact while still branching out.

2. Explore New Businesses

In some cases, a business wants to branch out into a completely different business category. They might not necessarily want to expand in their current market, but instead jump into a completely new one. Rather than changing the vision of their primary company, they can simply start a spin-off company through off-balance sheet financing. Many times, when a company says that it wants to get into a completely new market, it can scare the shareholders. By creating a new business entity, the company can choose to explore other avenues while leaving everything at the status quo for their main company.

3. Operating Lease

Another way that companies can use off-balance sheet financing is by utilizing an operating lease. An operating lease is a short-term lease that companies can use to obtain equipment that is generally very expensive. By leasing this equipment, they are not actually taking any of the ownership rights for the property. It remains the property of the leasing company and the company is simply paying a lease fee to use the property. By doing this, the company can keep the lease off of the balance sheet.

4. Building Leases

Building leases are another legitimate use of off-balance sheet financing. With this arrangement, a lender will purchase a building that a client can use. The company then pays the bank rent for use of the building. This type of lease does not appear on the balance sheet. With this arrangement, a company can find the perfect building that it needs to operate, but it does not have to take on debt to purchase it.

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