If you need new equipment but don't want to empty your bank account, leasing can be a cost-effective option.
Financing new equipment -- from computers to phone systems tocapital equipment and other gear you need to run your company -- isa major issue for many small business owners. Leasing, instead ofpurchasing, can be a cost-effective option, particularly if youdon't have the cash on hand, but need the equipment.
In fact, you might want to consider leasing even if you do havethe cash to invest. By leasing, you might find that you canregulate your cash flow more effectively, because you havepredictable, regular monthly installments as opposed to a singlelump sum payment. Plus, leasing can help you avoid tying up linesof credit, or you might want to use the money for another area ofyour business.
How leasing works
When you sign a lease you are assigning the rights for theequipment to the lessor. The lease-holder owns the equipment and ismaking it available to you for your use in exchange for the leasepayments you make. There are several ways to acquire equipmentthrough leasing. Among the most common are the following:
- Select equipment yourself and then seek financing through alessor. You locate a system from the vendor of your choice and thenwork out a leasing agreement for that system with the leasingcompany. In this scenario, you usually still get service andsupport for the system from the vendor, rather than thelessor.
- Select equipment by working with a retailer or manufacturerwhich offers leasing through its own subsidiary. Once a purchaseprice is established, your vendor will translate that into a leasepayment based on the terms you've requested.
- Obtain equipment directly through a lessor. If you choose thisroute, you will work with a leasing company to figure out what youneed and what you can afford. The lease and the equipment in thisscenario, comes from the lessor. If you choose to get your leaseand equipment from the lessor, you may want to shop for yourequipment before tackling the lease. A leasing company is notnecessarily the place to get your technical information
Advantages and Disadvantages of Leasing
Here are some of the issues you need to consider when you'relooking at leasing:
- Ownership -- The most obvious downside to leasing is that whenthe lease runs out, you don't own the piece of equipment. Ofcourse, this may also be an advantage, particularly for equipmentlike computers where your technology needs may change veryquickly.
- Total expense -- Leasing is almost always more expensive thanbuying, assuming you don't need a loan to make the purchase.For example, a 3-year lease for a $5,000 computer system (at atypical rate of $40/month per $1,000) will cost you a total of$7,200.
- Finding funds -- Lease arrangements are usually more liberalthan loans. While a bank might require 2-3 years of businessrecords before granting a loan, many leasing companies evaluateyour credit history on shorter terms (6 months is fairly typical).This can be a significant advantage for a start-up business.
- Cash flow -- This is the primary advantage to leasing. Iteliminates a large, single expense that may drain your cash flow,freeing funds for other day-to-day needs.
- Taxes -- Leasing almost always allows you to expense yourequipment costs, meaning that your lease payments can be deductedas business expenses. On the other hand, buying may allow you todeduct up to $19,000 worth of equipment in the year it is purchased(as part of first-year expensing); anything above that amount getsdepreciated over several years. With the first-year expensededuction, the "real cost" of a $5,000 computer systemmay be only $3,400.
- Technology needs -- Technology advances at a rapid rate. If youbuy a computer or other high-tech equipment outright, you may findyourself with outdated equipment in 2-3 years, with no discernibleresale value. Leasing may allow you to try out new equipmentconfigurations, and update your system regularly to stay on top thetechnology curve. On the other hand, if you have a"pass-down" policy in your company (where oldertechnology gets used by certain departments), buying may be moreeffective.
Terms to look for in a lease
Here are some of the issues you should look for when negotiatingyour lease, or reviewing your lease contract:
- Length of the lease -- This is often called the"term" of the lease, and is usually between 12 and 36months. The shorter the term of your lease, the higher yourpayments. 36 months is typical for a computer lease, although youmight want to look at a 24-month lease to keep up with changingtechnology. The cost of 12 month leases is usually prohibitivelyhigh, and many experts only recommend you look at this option ifyou have a compelling reason.
- Total cost -- Analyze all the charges for which you will beaccountable for the entire length of your lease. These include yourinitial down payment, monthly payments, a security deposit, anyinsurance charges, service/repair costs, etc.
- Cancellation clause -- This allows you to break your lease,although you will be liable for substantial penalties. This way, ifyou close your business, change its focus, or no longer need apiece of equipment, you won't be liable for the entire term ofthe lease.
- Assignment -- Find out if you can assign the lease to anotherparty, and if so, what it costs.
- Modern equipment substitution -- If technology changes rapidly,you might want to consider this option. This allows you to updateor exchange your equipment so you don't get stuck withsomething that's obsolete.
- Service plans -- Find out if your lease comes with an on-siteservice plan, and if so, determine its length. If you have only 1year of on-site service, you may need to extend it to the length ofthe lease; otherwise, you will be responsible for all repairsyourself after the first 12 months. Also, be sure the contractspells out when the service will be performed (ideally, nextbusiness day).
When a lease is not a lease
Read the fine print of any lease you sign. There is such a thing asa lease that the IRS considers as a purchase -- which means youwould not be able to deduct your monthly payments. A capitalpurchase has occurred if the terms of your lease agreement areconstructed so that you meet one of the following criteria:
- You have a "bargain buyout" in which you can purchasethe machine for a token amount at the end of the lease.
- You are leasing the machine for 75% of its useful life.
- The total payments made during the period of your lease equalmore than 90% of the fair market value of the machine. Keep in mindthat payments include finance charge and sales tax, and they needto be deducted to find the true price you're paying for theequipment.
The viewsand opinions contained herein are not necessarily those of AmericanExpress and are intended as a reference and for informationalpurposes only. Please contact your attorney, accountant or otherbusiness professional for advice specific to yourbusiness.
Copyright © 2002 American Express Company. All RightsReserved.