How to Start Your Own Air Charter Business
- December 8, 2019
- Posted by: Jimmy Ombom
- Category: Online Business
One of the most pertinent features of the contemporary airline market is that airlines today come and go, which means that as one airline exits a specific market, it is replaced by another airline, usually an airline start-up.
Moreover, there has been an exponential rise in the number of low-cost airline carriers, which has led to the market entry of numerous new airlines over the past ten years.
In essence, airline start-ups need to access two primary funding sources that include aircraft finance and working capital. Indeed, Abu-Taieh (2011: p58) notes that while an airline may put together the best management team and business plan, failure to access sufficient funding and finance makes short term success of the airplane impossible.
At present, start-up capital required to finance the working capital needs is readily available by historic standards, specifically if the project is right for investors.
This article analyzes possible sources of funding for an investor seeking to launch an airline start-up, while also discussing the advantages and disadvantages of the different sources of funding.
Moreover, the article will seek to identify factors that investors are likely to consider prior to evaluating funding requests.
Sources of Funding for Airline Start-up
Direct Lending and Direct Purchase Agreements
One source of funding that an airline start-up could use is direct lending. In this case, an airline could decide to take out an unsecured or secured loan as working capital but more specifically to purchase commercial aircraft.
Moreover, the airline start-up may receive a loan for a syndicate of banks since the transaction may be quite large. Since commercial aircraft costs could reach several hundreds of millions of dollars, security interest accompanies most aircraft purchase direct lending, which means that the loaning bank could repossess the aircraft if the start-up fails to pay back the loan.
Generally, obtaining private financing that is unsecured to purchase an aircraft is very difficult unless the airline start-up is considered especially creditworthy.
Still, there are some governments that use the Large Aircraft Sector Understanding to fund exports of aircraft produced domestically, an agreement is providing for aircraft purchase financing at close to 175 points for ten years over the prime rate.
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A more specific form of direct lending in the airline sector is the direct purchase agreement, in which the airline start-up buys the aircraft from the vendor or manufacturer directly using a structured finance lease or a secured mortgage loan.
In this case, the advance amount for the aircraft could vary by almost ninety percent, which will be dependent on the start-up airline and the capital it has available.
Generally, such loans are structured in a mortgage style amortization with a term of up to twelve years, while the interest rates could either be floating or fixed in nature.
As noted above, several lenders are likely to come together and form a syndicate, which will provide the start-up airline larger loan packages. Direct purchase agreements possess several advantages when used to directly buy aircraft for a start-up airline.
For example, a start-up airline that uses direct lending or direct purchase agreements can build up equity in the purchased airplanes as it repays the finance lease or the mortgage.
Moreover, the start-up airline will own the aircraft they purchase, which means that they can continue to modify the airplane to its preferred exact requirements.
Finally, direct purchase agreements have an advantage in that the start-up airline that owns the aircraft can gain substantial benefits of taxation in the majority of countries.
However, the use of direct lending or direct purchase agreements has several disadvantages for start-up airlines.
For instance, at the end of the lending or purchase agreement term, the start-up airline will be subjected to residual value risks.
In addition, this source of funding presents a form of ownership that is less flexible, especially when compared to operating leases that will also be discussed.
Finally, Using this source of funding for a start-up airline could weigh down the start-up’s balance sheet, in turn influencing other covenants made with banks.
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Generally, start-up airlines can lease commercial aircraft through the GE Commercial Aviation Services and the International Lease Financing Corporation, which are offered by commercial Aircrafts Leasing and Sales companies.
Typically, operating leases tend to be short term with a duration of up to ten years, which makes them especially attractive for start-up airlines, although it is also attractive for established carriers that wish to expand tentatively.
Such a short duration is particularly useful in preventing airplanes from being rendered obsolete, which has become especially important in many countries because of changing environmental and noise laws.
For countries where a start-up airline may be considered less creditworthy, such as in less economically developed countries, this source of funding may be the only choice where start-ups want to acquire new aircraft.
In addition, using operating leases gives the start-up airline more flexibility, which enables them to more closely manage the composition and size of their fleet, thus contracting and expanding their fleet in response to demand.
The residual value of the airplane when the operating lease ends is a critical consideration for aircraft owners, specifically, since they could require that the start-up airline returns the aircraft in the same condition maintenance-wise as was delivered to enhance the next operator’s turnaround. Security deposits are required for operating leases, just as in other funding fields.
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The wet-lease is one form of operating leasing, whereby an airplane and a crew are leased together. Normally short-term in nature, wet leases are meant to cover demand fluctuations, such as during the tourism season. In this case, the aircraft operates using the airline code of the start-up airline, as well as part of the start-up airline’s fleet, although it normally keeps its owner’s livery.
Different countries have different operating leases accounting rules, in which some like the UK allow for the capitalization of expenses from operating leases on the balance sheet of the airline, while others like the US generally report expenses from operating leases as operating expenses.
Another form of an operating lease is the dry lease, in which the entity leasing out the aircraft provides the aircraft but without maintenance, supporting equipment, ground staff, crew, and insurance. In this case, the leasing company requires the lessee to provide registration for the aircraft, as well as to put the leased aircraft on their air operator’s certificate.
Generally, a dry lease has a time period of at least two years, while it also bears particular conditions related to insurance, maintenance, and depreciation, which are all dependent on political circumstances and geographical locations.
The start-up airline may also make a dry lease agreement with a major or regional airline, in which one of the latter provides maintenance, flight crews, and other aspects of aircraft operations, after which the aircraft may then be operated under the name of the start-up airline. As such, it will save the start-up airline expenses related to training the aircraft personnel, as well as maintaining the aircraft.
Another form of operating lease is the damp lease, in which the leasing company provides the flight crew, aircraft, and maintenance. However, the leasing company does not provide the cabin crew, which will be the responsibility of the cabin crew. However, this can only be done if the start-up airline provide their cabin crew with safety and emergency procedure training, which is critical for the crew to become acquainted with the airplane’s differences.
The start-up airline is usually required to at least give the leaser a security deposit of three months rental that the leaser returns when the lease ends, although this is dependent on the aircraft being returned in the agreed-upon condition.
Market demand is a critical determinant of monthly costs of the rental, although Bowyer and Davis (2012: p370) approximate that most monthly rental costs are roughly 1% of the aircraft’s purchase cost. Just as with direct lending and direct purchase agreements, operating leases have several advantages, one of which is that the start-up airline has reduced initial capital requirements. In addition, operating leases eliminate residual value risk, which will be retained with the aircraft’s owner or the leaser.
Moreover, operating leases have less banking restriction impacts as liabilities are not included on the balance sheet. However, this source of funding has several disadvantages, such as the fact that the lessee owner retains all the aircraft’s built-up equity. Operating leases also avail smaller tax benefits in general. Finally, it is possible that the aircraft’s owner could impose restrictions on the aircraft’s use that is erroneous.
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Also referred to as capital leasing, finance leasing is an arrangement whereby start-up airline will come closer to being the “owner” of the leased aircraft, especially since it is generally loner-term in nature compared to operating leases.
In this case, the transaction is more complicated whereby the leaser buys the airplane through equity financing and debt, after which they lease the aircraft to the airline start-up. Thus, the airline start-up could opt to buy the airplane when the lease expires, while they may also receive the airplane when the lease expires.
Generally, a finance lease involves the leaser getting most of the rights of aircraft ownership, as well as where the present minimum lease payment values for the lease’s period is more than 90% of the aircraft’s fair value on the market. As such, a finance lease is considered as the start-up airline’s asset, as compared to operating leases where the aircraft only affects the cash flow of the start-up airline.
Finance leasing is especially attractive to start-up airlines because they can claim deductions based on depreciation over the useful life of the aircraft. This, in turn, offsets lease profits for the purpose of taxation, while also enabling the deduction of paid interest to creditors involved the purchase’s financing.
As such, aircrafts have become increasingly attractive for investors seeking tax shelters, while also making finance leasing cheaper to direct purchasing agreements and operating leases. There are several types of finance leasing available to airline start-ups. One of them is the equipment trust certificate, which is where investor trusts buy an aircraft and lease it to the start-up airline.
In this case, the start-up airline is required to receive the aircraft’s title when the lease is completed. According to Pilon and Sonokpon (2014: p44), equipment trust certificates are increasingly becoming a hybrid between secured lending and finance leasing, tending more towards securitization agreements.
Secured lending is also a form of finance leasing, whereby the start-up airline has to pledge some of its assets to act as loan collateral, in turn becoming a secured debt that the creditor will be owed by the start-up airline. Where the start-up airline is unable to repay the loan, the assets will be possessed by the creditor, after which they may sell it as a way of regaining the loan that the start-up airline had originally borrowed.
Where the sale of the property held in collateral fails to cover the entire loan lent to the start-up airline, the lending entity may seek a deficiency judgment for the amount remaining from the start-up airline. Secured lending may generally attract lower rates of interest because of the lender’s expected returns as compared to unsecured lending. However, expected returns, ability to repay, and credit history are also factors that influence the interest rate.
Finance leasing has several advantages, one of which is that the capital lease has numerous qualities of an aircraft purchase. Lease terms for the aircraft will extend for almost 75% of the aircraft’s lifetime, which means that the airline start-up will get more from the aircraft as compared to the aircraft’s real owner.
Finance leases also provide the airline start-up with the option to purchase the aircraft when the lease ends, normally at a market discount price. Another advantage has to do with tax deductions; particularly regarding the fact that the start-up airline can claim tax deductions on the finance lease’s cost.
In this case, the start-up airline can acclaim deductions for every year they operate the leased aircraft, which is considered as depreciation. However, finance leasing also portends several disadvantages to the airline start-up. One of these has to do with reporting, whereby the start-up has to record the capital lease agreement in their financial statements.
As such, all future lease payments at present value are included as debt, which increases liability value on the start-up airline’s balance sheet. The start-up’s finances see less attractive as a result, imposing banking restrictions for future borrowing.
Thus, some start-up may seek to avoid finance leases so as to reduce their balance sheet liabilities. Finally, finance leases also possess a disadvantage regarding maintenance responsibilities, in which the start-up airline has to care for the maintenance and repairs of the leased aircraft. In turn, this could reduce the firm’s profits as it increases expenses.
Moreover, any long-term deterioration of the aircraft during the term of the lease will mean that the start-up has to purchase the aircraft and take full ownership. This means that any decline in the aircraft’s value in case it is made obsolete by new technology or it sustains damage will cause the start-up to suffer losses.
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Factors of Interest to Potential Investors in the Airline Start-Up
One of the aspects that investors will look for prior to investing in start-up airline is whether there is a market for the airline’s operations. As such, the start-up airline must be prepared to answer crucial questions regarding the customers being targeted in the market, why they would want to fly the airline, and the market problem that the airline is seeking to solve.
Another aspect that the investor will be interested in has to do with the nature of current competition in the airline market. Majority of investors will be interested in comparing the start-up airline’s ideas to those of other airlines in the same market. Investors will also be interested in knowing whether the timing for the business is right, especially with regards to the timeline of expected dates and events and issues that may go wrong in achieving the objectives stated in the timeline.
In relation to timing, the investors will also consider where the start-up airline stands in terms of reality and transition paradigm. Moreover, the investor will also consider the scale of the opportunity, specifically by identifying whether the start-up airline understands the future of the airline business, as well as the goals that the start-up airline has already met and how these have driven forward the business.
Yet another aspect that the investor will include in their checklist is the availability of resources, which they do by considering whether the start-up airline’s financials are strong, as well as whether there is a clear plan on how the funds from the investor will be used. Moreover, they will also seek to identify how much the start-up’s owner is putting into the business. Investors will also consider whether the team in place can achieve the aims set out by the start-up.
In this case, the investor will look at whether the team assembled by the start-up has the experience required to successfully pursue their objectives. Investors will also be quite interested in the business model pursued by the start-up, including the economics of the business unit’s base and how it compares to that of its competitors, whether the company’s business practices are sustainable in the medium and long term, and the operating metrics that the start-up uses to measure their success.
Finally, the investors will also look for the start-up’s exit strategy, especially with regards to whether the exit strategy will enable them to generate the desired returns from their initial investments. Exit strategies may involve selling the start-up airline, setting up an initial public offering, or pursuing a merger.
As noted in the discussion above, one of the most difficult aspects of setting up a start-up airline has to do with getting financing to start its operations. Possibly the most important financing aspect in a start-up airline is the purchase of aircraft. This paper has identified three major sources of airline financing, which are direct lending and direct purchase agreements, finance leasing, and operating leasing.
From the identified advantages and disadvantages of the three modes of financing, a start-up airline would be best served by using a direct purchase agreement, in which the airline start-up buys the aircraft from the vendor or manufacturer directly using a structured finance lease or a secured mortgage loan.
By using direct purchase agreements, the start-up airline can build equity in the aircraft they buy as they repay the finance lease, while they will also own the purchased aircraft. Most importantly, they can also gain significant tax benefits.