Equipment Appraisal Blog | Understanding Machinery Appraisals

Commercial lenders such as banks, credit unions, and alternative financiers each may have unique approaches to risk tolerance and lending parameters. But they tend to look at industrial machinery and equipment through the same lens: “If this loan defaults, how much will I recover from this collateral?”

An independent equipment appraisal helps lenders understand collateral strength and liquidation risks.

The Commercial Lender’s Perspective

For borrowers, equipment is a contributing factor to business earnings. Business owners see each piece of equipment as a revenue-generating asset. This often causes a disconnect between lenders and borrowers, because lenders are not generally concerned with the value of individual assets in a going concern.

The reality is that at a high level, lenders are focused on two broad outcomes: either the borrower performs as agreed, or the lender will have to evaluate alternative recovery options.

In Situation 1, the market value of the business assets has limited relevance to the lender. Cash flow and payment performance take priority as long as the loan is current. Whether a particular machine is worth $1 or $100,000 is not particularly important.

In Situation 2, the lender may have to decide whether to renegotiate the loan or whether to liquidate their collateral.

In either situation, lenders focus on repayment and recovery outcomes rather than maximizing the operating value of the business itself. If a borrower defaults, the lender is generally not going to repossess and operate the business as a going concern. They are in the business of lending and finance, not business operation.

They are going to either restructure and work toward repayment, or they are going to cut their losses and liquidate the business.

Special Assets and Workout Departments

If a borrower defaults on their commercial loan, the loan often moves to a department of the bank called “special assets” or “workout.” (Special Assets refers to the lending team responsible for managing high-risk or distressed loans. Workout is the active process used to restructure a loan or recover collateral.)

In smaller banks where employees may wear multiple hats, the two terms are often used interchangeably to refer to the same concept: a loan that is in default. In these cases a lender’s mindset may shift; the loan is no longer a certain revenue-generating asset, but rather a puzzle which can only be solved with information, consideration, and thoughtful decisions.

The lender’s priorities are complex. They must balance minimizing risk, preserving community reputation, preserving borrower relationships, maximizing return potential, and minimizing legal battles, among other concerns.

When commercial machinery and equipment (M&E) collateral is involved, the first step for the lender is to understand the market value of the assets.

Realistic Outcomes for Machinery and Equipment Collateral

There are many ways to consider market value for business equipment.

• “How much would it cost me to replace these machines?” This is useful for insurance purposes.
• “How much life does this facility have left before major replacements are required?” This is useful for transactional due diligence.
• “Are all of these machines active and earning income for the business?” This is useful for Fair Value and financial reporting appraisals.
• “What would I get if the business closed and we sold these machines?”
• Fair Market Value estimates what the equipment may be worth if offered in a willing buyer, willing seller situation, and an extended period is allowed for resale.
• Orderly Liquidation Value estimates what the equipment may be worth if offered as-is, where-is, with a reasonable time allowed for liquidation, such as 3-6 months depending on the equipment type.
• Forced Liquidation Value estimates what the equipment may be worth if sold as-is, where-is, in a public auction or in a similar environment where buyers are assuming all risks and required to purchase immediately.
• A low M&E appraisal may encourage the lender to allow the business to continue operations as the most likely way to recoup some financial return. However, a low appraisal may also push the loan over a minimum debt-to-equity threshold which could send the borrower further into a special assets spiral.
• A high equipment appraisal may allow the borrower to claim more collateral than expected and restructure their loan favorably. However, a high appraisal may also convince the lender that an immediate liquidation will provide their easiest and best financial return.

But for a commercial lender, only one question is important:

The reality is that if a loan defaults, the lender is not often able to sell an entire facility as a going concern. In the majority of cases, the business is liquidated and the personal property, real property, and any other business assets are sold piecemeal in the open market.

The M&E can be sold under varying terms and timeframes, which create the different levels of value commonly used by lenders:

Because of the different levels of risk and timeframes involved, FMV tends to be the highest value, with OLV and FLV each lower. The differences between each value type can be very large or very slim depending on the equipment type and situation.

The M&E Appraiser’s Role

The lender cannot determine the most appropriate path forward for a distressed loan without understanding the likely outcomes of each alternative. Collateral value is only one input in that decision. Lenders must also weigh borrower cash flow, guarantees, customer concentration, management quality, and other factors that influence recovery outcomes.

The equipment appraiser’s role is to advise the lender of the likely results of an equipment liquidation, including risks, potential complications, and financial return.

The equipment appraiser does not always know how their assignment results will be utilized. Oftentimes borrowers will believe that a higher or lower value will help their cause, but the reality is more nuanced.

The appraiser must be unbiased and disinterested in the outcome. Their job is to provide professional opinions and informed context to their client; the commercial lender has the ultimate job of deciding how to utilize the appraisal results.

When appraising machinery and equipment, clients may believe that the estimated value translates to a sure bet that it will sell for that price. It is important that your report distinguish between the two concepts. There are variables, both known and unknown, that could play a part in the final sale outcome. An appraisal is an independent opinion based on sound research and does not guarantee the ultimate disposition price of the asset.

The appraised value of any piece of equipment is based on a combination of market and cost data, which looks at factors such as comparable sales and depreciated replacement cost. This is a solid foundation and provides an estimate of what the equipment is worth as of a specific effective date. The definition of value may be at a fair market or liquidation level, which will dictate a materially different resale market price level. If the appraisal is estimated at Fair Market Value and the seller places it in an auction, the price realized will be very different than the estimated value.

The condition of the equipment will impact both its worth and potential sale price. Proper maintenance and upgrades can maximize its value, while excessive wear and tear and outdated technology can bring it down. Most accredited equipment appraisers are not mechanics and assume the assets are in normal operating condition unless informed otherwise. Even when an appraiser adjusts value for a lesser condition, a buyer may believe there are significantly more repair costs involved to bring the machine into good operating condition.

For custom-built equipment, the resale market will be limited. An appraiser assumes the equipment will be sold to another user who will pay a fair price; however, finding the right buyer may take significantly longer, which will affect the price.

Buying and selling are often about psychology as much as they are about numbers. Buyers often want a deal or a sense that they are getting something special. This means the equipment might sell for less if there are concerns or doubts—even if it is technically worth more. How the sale is negotiated, the relationship between buyer and seller, and the urgency of either party can all affect the closing price.

Understanding that there may be a gap between an item's appraised value and what it might sell for is key to setting realistic expectations. Research the market, consider the timing, and prepare for negotiation. By doing this, you can find a fair middle ground that respects the equipment's worth, while also being competitive in the current market landscape.

Regardless of the state of the overall economy or particular industry, there is always a demand for machinery and equipment valuation work. It is essentially a recession-proof business. There are potential customers across various market sectors seeking experienced appraisers to assist with their transactional or dispute-resolution matters.

Here are a few examples of the more common client types:

Business Owners

Companies that use a lot of equipment in their day-to-day operations will look to buy used equipment to replace older assets that need to be sold in the secondary market. Appraisers can assist in both ends of these situations. Owners will also need valuation work when acquiring other businesses for tax and accounting purposes.

Financial Institutions (Collateral-Based Lending and Leasing)

Whether it’s a traditional bank looking to support a loan or a leasing company wanting to set realistic residual values and resell returned equipment, accredited machinery appraisers are involved in valuing on both the front and back ends of these deals.

Private Equity Groups

In the merger and acquisition (M&A) market, private equity will target investments in certain equipment-based companies. They make a long-term growth acquisition or a shorter-term buy-sell opportunity. Machinery appraisals are needed from a risk, accounting, and tax perspective.

Attorneys-Partner Dispute Work-Divorce-Insurance

For experienced appraisers with the right credentials, there are plenty of opportunities to team up with law firms on business disputes, divorce cases, insurance claims, or tax and accounting issues, and to get involved in litigation support work as an expert witness. This creates the ability to build up a resume of testimony experience as well.

Individual and Corporate Donors

Donation appraisals are quite common as businesses and individuals will give their used assets to technical schools, universities, museums, and other non-profits, requiring a qualified appraisal for items valued over $5,000.

In summary, this broad range of clientele affords machinery and equipment appraisers several avenues for effectively growing their businesses.

Developing a foundation to be an accredited M&E appraiser can come from many different career paths. Although some candidates start right out of college, having worked in another capacity in the machinery industry can have additional benefits.

Gaining experience as an asset manager in the equipment finance and leasing industry is a common profession that leads to independent valuation work. The credit risks associated with lending and investing need to be leveraged with the ability to better understand the value of the assets being collateralized. Properly estimating value throughout the deal term will lead to better upfront decision-making and future outcomes should the equipment be repossessed or returned in a default or end-of-lease scenario.

Later in their careers, asset managers may decide to work for independent valuation companies or accounting firms with appraisal divisions.

Another parallel career is used equipment sales and remarketing, either as an auctioneer or a machinery dealer specializing in certain industries such as heavy equipment, transportation, and manufacturing. Learning about the secondary market firsthand, where you see real-time used-equipment sales every day, is a great way to develop the skills necessary to become an independent M&E appraiser.

Equipment dealers sell in both retail and wholesale environments, which translates to fair market and orderly liquidation value comparisons. Auctioneers are typically buying and selling in a more distressed setting that lends itself to a forced liquidation value. Companies in these industries often develop databases of historical resale prices that can be used to accurately estimate the value of used equipment.

This is another area where certain individuals working for these companies might decide to focus on valuation more exclusively and strive to become an accredited ASA MTS appraiser.

Anyone working in businesses that have a heavy focus on machinery and equipment, either from a resale or operational perspective, will be able to use their skills to gain a leg up on becoming an independent appraiser. Professional appraisal work is a specialized skill that offers the opportunity to help clients in different scenarios that require an unbiased opinion of value, whether to close transactions or settle disputes.

Having the right background that establishes your credentials goes a long way to becoming a successful ASA MTS appraiser.

If you own a business that has a lot of productive machinery & equipment, consider maximizing its working potential by tapping into its other benefits. Asset ownership offers many benefits, including the ability to convert hard-earned equity into cash. Access to working capital will allow you to invest in other areas of your business, such as expanding operations and upgrading or adding more machinery to meet growth needs.

We all know equipment depreciates over time, unlike land and buildings; however, it will continue to hold significant value over the years if it is well-maintained. If you initially paid cash, or loans have been paid off, even though you have fully depreciated the assets on your books, actual market value can be determined and used as the basis for new working capital that results in a significant cash infusion for your business.

When you begin working with a bank or other financial institution, take the time to develop a detailed listing of all your M&E, while providing access to your original purchase documentation. The most important data to include would be the general description, year, make, model, and serial number/VIN for each item. Specifications such as production capacity, size, length, and tonnage will also be useful.

Keep in mind the bank is investing in you and your company, while taking a lien against the equipment as collateral; therefore, it will be important for them to get comfortable with the transaction and associated risk. Most lenders will approve a certain percentage of Fair Market Value or look at a more conservative liquidation value as the funding level for the loan.

A critical next step will be to engage with an experienced, accredited M&E appraiser who can independently support the value of your assets. They will research the industry and develop opinions of value at various resale levels in the market, while utilizing sources who are involved with the sale of new and used machinery. The lender may allow you to arrange for the appraisal directly or prefer to oversee it themselves. In either situation, you will need to participate throughout the process to ensure the appraiser has the optimal amount of information to best understand the history and status of your assets.

An independent appraisal report will support a reasonable value for all your M&E, so you can get approved for that working capital loan your company needs to continue to grow and be successful today and for years to come.