To Lease or Not to Lease
Last year, Valarie Moody needed two costly photo printers for Fodeo, her photo and video preservation shop in Countryside, Ill., but she didn't want to deplete her cash reserves in the middle of an economic downturn. She was unsure about getting credit or a traditional bank loan, as two of her business credit cards were cancelled out of the blue, one due to a bank closure. In the absence of other good options, Moody decided to lease the printers and found she got lower payments and more buyer protection than she would have expected with traditional bank financing.
"I particularly liked the lease experience because we had a problem with one of the printers, and if we had purchased the printer outright, we probably wouldn't have been able to return the printer as easily," Moody says. "Since the leasing company withheld payment until we were satisfied with the product, we were able to get the seller's attention and return [the printer] after several different software trials failed. The lease was much easier to obtain than a traditional loan, and they guaranteed the equipment."
While bank financing remains elusive for many small businesses, lease financing is a viable, but little understood, alternative. "So many business owners think they have to go to a local bank [to get a loan], and they're surprised to find there are all these leasing companies out there, financing $500 billion-plus in business equipment each year," says Ralph Petta, interim president of the Equipment Leasing and Finance Association.
In fact, small businesses use computers, trucks, furniture, factory machinery, airplanes and other types of equipment that were purchased through lease financing. For many of these companies, leasing is not just an alternative to a bank loan or credit card debt; it's a deliberate financing strategy.
"Businesses that can retain or expand their cash and bank lines have the best chance of surviving in this business climate," says Joel Ronan of Atlantic Business Credit, a lease financing firm in Stuart, Fla. "Any credit lines you can establish or expand--be it with vendors, banks or equipment lessors--will allow you more breathing room." Ronan adds that there are many businesses that are failing because of cash flow problems. Some of those businesses may even be profitable, but their cash is tied up in inventory or receivables. Equipment is an alternative line of credit that allows for greater liquidity.
Bank Loan Reject? No Problem
Moody says her equipment lease was much easier to obtain than a bank loan, and leasing industry professionals say that's no accident. Banks and leasing finance companies are set up differently and are often looking at different criteria when it comes to loaning money. "Generally, equipment finance specialty companies will give greater consideration to the collateral value of the equipment than a bank because they have more specific experience with the equipment and may be better equipped to recover a loss if their customer defaults," says Robert Boyer, president of Susquehanna Commercial Finance, Inc., and chairman of ELFA's Small Business Steering Committee. "There are some advantages a lessor has on a lease that a lender does not have with a loan in the event of a bankruptcy, so there may be structures that an equipment finance company can use to get a higher level of comfort on a transaction."
In other words, even if your company has been turned down for a bank loan, that doesn't mean you won't be approved for lease financing. "Particularly for equipment leases under $15,000, transactions flow freely, even for startups or [companies with] credit scores in the low 600s," Ronan says. "Leasing can serve as a reasonable alternative for bank declines."
In fact, some banks have equipment finance divisions or subsidiaries that offer leasing services to their clients, Boyer says. And currently, as federal regulators have tightened their position on how much commercial real estate lending banks can carry, "they want banks to increase their percentage of commercial and industrial lending," says Erik Dickinson, vice president of equipment finance and leasing at Red Mountain Bank in Birmingham, Ala. "This would be lines of credit and equipment financing."
Beyond Paying Rent
Unlike leasing an apartment, some business leases are more like loans, so the business actually owns the equipment and can receive tax benefits through its depreciation. (A new legislative proposal under consideration by Congress would allow companies to expense these assets and write them off more quickly than is currently allowed.)
But in some cases, a true lease, in which a business pays rent on the equipment until the life of the lease expires, can make more sense than purchasing. At Women's Health Specialists in Jensen Beach, Fla., administrator Bill Hughes, CPA, prefers to lease equipment that becomes outdated quickly, such as diagnostic equipment and personal computers.
"Advances in technology usually make the equipment obsolete by the end of the financing term," Hughes says. "Not owning the obsolete equipment at the end of financing does not put you in the bind of having to store or dispose of the old equipment."
Benefits to Enjoy
For companies in a cash-flow crunch, the most valuable advantage to leasing is the ability to hold onto their cash. In most cases, a company can get the equipment it needs with little or no down payment, allowing it to preserve working capital and lines of credit for other uses, Dickinson says.
And unlike the lengthy approval process for most loans, lease transactions can happen fast; many lease transactions under a certain threshold can be approved within 24 hours. "Most equipment finance companies will review credit based on a simple, one-page application if the transaction is less than $50,000," Boyer says. "There are many companies that have higher thresholds, maybe even as high as $250,000 for certain industries. Anything over this application-only threshold will generally require the applicant to submit tax returns or accountant-prepared financial statements."
Even those transactions that require a complete credit package are often processed within 10 days, Ronan says. "Of course the rates are higher, but many times the lease payment is not material when you consider the income the new leased equipment generates or efficiencies it creates in the business," he says.
Finally, leasing can offer tax benefits. For Women's Health Specialists, the ability to immediately include the total payment as a business expense, rather than writing off only the interest and eventual depreciation of the equipment, is one of the most important reasons to lease, according to Hughes. For instance, "Car leases allow you to write off the entire payment versus interest expense and depreciation," he says.
Pitfalls to Avoid
While scores of business owners successfully lease equipment and enjoy the accompanying tax and cash-flow benefits, many others have had negative leasing experiences. For instance, the credit card machine industry is notorious for problematic leases, Ronan says. "In many cases, a low-cost item, say $500, is leased on a continuous basis at something like $35 per month," he says. "Historically, these leases go on for years with tremendous yields to the lessor. Resentments grow when the lessee understands years later he has paid for the thing several times over. Beware of any company that will not sell but only leases. You are probably going for a long ride."
To avoid similar problems, keep these tips in mind:
- If you're unfamiliar with the finance company, conduct a background check. Boyer recommends using Dun & Bradstreet reports or the Better Business Bureau.
- Before signing anything, find out what happens at the end of the original lease term. For instance, you may have an option to purchase the equipment at a deep discount. Whatever the terms are, make sure they are explicitly determined and in writing.
- Find out the fees associated with the lease transaction," Ronan says. Some common fees include documentation fees and late fees. "Many quotes with low rates are rich with fees," he says.
- If a down payment or deposit is required with your application, "make sure there are specific terms that spell out the offering being made and what will happen to the down payment if the company is unable to approve the transaction," Boyer says.