An equipment lease is a contract for the use of a specific piece, (or multiple pieces of), equipment or furnishings for a specific period of time and for specific lease (rental) payments agreed upon in advance.
The lessor is the owner of the leased equipment and makes the initial cash investment for its purchase. The lessee is the user of the equipment and gets all the benefits of its use, just as if they owned it. Leasing lets you finance the use, without having to finance the purchase. However, if at the end of your lease the buyout is structured to be $1.00, then leasing becomes the same as if you financed the equipment through your local bank whereas you now own the equipment at the end of your term.
All kinds and sizes of businesses, from the largest multinational companies and professional practices, to “mom ‘n pop” businesses and individual proprietors. Businesses use equipment leasing as a way of acquiring the use of the tools or furnishings they need to be productive and profitable.
According to industry and government statistics, 80% of all businesses lease at least some of what they use; an estimated $180 billion dollars worth of equipment in 1998. Any growing business can benefit from using equipment leasing. It provides a practical way to stay abreast of the latest trends and use the newest, most productive equipment without draining valuable equity cash from the business or tying up important bank lines of credit. Tying up cash in fixed assets can severely restrict the ability to move quickly on other opportunities.
There are as many reasons for leasing equipment as there are business who do, but some of the most often cited by those businesses are: Make money using, not owning, new equipment
Remember, your business makes money by using your equipment, not by owning it. A plan which lets you defray, delay or diminish costs by using someone else’s equipment may be more practical than buying your own. Use cash for other reasons
Fast growing, successful businesses recognize the need to move quickly on income opportunities. They want their cash and bank credit lines available and not tied up in depreciating assets. Faster write off
A properly written lease may offer you the fastest possible way to write off the costs of using new equipment. This lets you use money you would have paid in taxes to help keep your business modern and competitive. Hedge against obsolescence
Also, by writing it off faster, you avoid making long term commitments to rapidly changing technology. Under the current MACRS, (Modified Accelerated Cost Recovery System), depreciation schedules, it may take you 6 or 8 years to fully depreciate the purchase of technology you may only use for 3 years. Computers, telecommunication systems, and medical equipment are all good examples. Cash Flow
Equipment Leasing generally requires the least amount of up front cash to get new equipment in place and working for you.
Leasing is a practical way to use new equipment and compares favorably with other forms of financing, costing you about the same. That, of course, is no coincidence; the marketplace demands it and leasing rates are set accordingly. The truth is it costs you about the same to lease equipment as it might to buy it. Businesses lease for cash flow and other reasons as cited above. What’s the interest rate?
Because you’re not borrowing any money when you lease equipment, there’s no interest rate on the lease like there would be on a bank loan. You can, however compare the cost to lease with the cost of a loan.
Applications through approval
The equipment leasing process is pretty simple and straightforward. You select the equipment or furnishing you need from the supplier of your choice, then make an application to the leasing company describing what you want and where and how it will be used. The leasing company wants to know that you are able and willing to make your lease payments and so they do a standard credit check much like a bank would do. Like a bank, they’ll generally require the personal guarantees of the owners for newer businesses and closely held corporations. Documentation and ordering equipment
Once the lease is approved, they’ll ask the owner or president of the business to sign the lease agreement. Depending on the type of lease and the amount of leased equipment, the lease agreement may include one or more schedules listing the leased equipment and the terms.
Acceptance and lease beginning
Once the lease is signed and received by the leasing company with the appropriate initial payment and security deposit, the leasing company issues a purchase order to the equipment supplier you’ve chosen. When the equipment is acceptably delivered to you, they’ll ask for a delivery and acceptance form to be signed. The equipment supplier is paid and your lease actually begins at that point.
An established business with a good credit record can lease equipment. Most leasing companies would like you to have been in business for two or more years. Bank, trade and other financing references may be required. Depending on the equipment cost, financial statements may be necessary. Personal Guarantees
Personal guarantees are generally required from the owners of closely held corporations or newer businesses. The leasing company relies largely on the commitment of the owners as an indication of the confidence the owners have in the business. New businesses
Though most leasing companies prefer to work with established businesses, equipment leases can be done for new businesses, too. For new businesses, the financial strength of the owners will be of paramount importance and their personal guarantees will always be required. Additionally, the leasing company may ask to review business plans, pro forma financial statements, supplier contracts or other pertinent information. They’ll frequently request resumes from the owners to show relevant prior experience.
Equipment leases can be written for a variety of terms but typically range from 12 to 60 months. The most popular term is 36 months. Most leases are monthly but quarterly and annual payment leases are also done.
Also available are step payments, wherein the lease payments start out low and increase each year; delayed payments, wherein the equipment can be installed and used for several months before the lease payments begin; seasonal payments, wherein the payment schedule can be set to match the seasonal cash flow of the business; and a variety of other customized terms. All of the above leases will fall into one of these broad categories:
Sometimes called “tax” or “FMV” leases, these are designed to meet IRS tax guideline definitions of a lease and may offer you the fastest way to “write-off” the use of new equipment. Leased equipment may be re-leased, purchased, returned or traded in at the end of the lease.
Frequently called “$1-Buy-Out” leases, these transfer ownership for a token sum at the end of the lease. They’re basically a sales finance type contract. They offer the convenience of leasing for those not needing the full tax deductibility of their lease payments.
This type of lease can be designed to meet accounting standards for off-balance sheet financing according to FASB (Financial Accounting Standards Board) rules.
In this type of lease, the lessor purchases the leased equipment from the lessee who leases it back from the lessor and continues to use it. It’s an effective way to free up working capital which may be tied up in fixed assets.
What happens at the end of your equipment lease is up to you. You may make that decision at the beginning by the type of lease you choose or you may want to choose a lease that allows you the flexibility of waiting until the end of the lease to decide. Generally it will be one of these choices:
On true, tax type leases, the purchase price is negotiated between you and the leasing company. Sometimes an independent appraiser can be called in to help establish a “Fair Market Value”. Frequently this is pre-estimated at 10% of the equipment’s original price. Lessees who keep in mind that the leasing company doesn’t want to end up with the equipment at the end of the lease generally are able to negotiate the most favorable purchase options.