Leasing. When some people hear the word they think of cars. With others it’s apartments or property. But what about industrial equipment? Compared to conventional avenues, equipment leasing is a completely different financing option.
Equipment leasing is quickly becoming one of the most popular ways to acquire equipment. According to the Equipment Leasing and Finance Association, in 2006 approximately $229 billion in new equipment was acquired by American businesses through leasing. Why? That’s what we’re going to look at in the next few pages: what equipment leasing is and why it can be a great option for financing your equipment purchases.
Let us start by defining the term “lease.” A lease is essentially a usage agreement between a business entity and a financial institution. The financial institution or leasing company is purchasing the equipment on the business entity’s behalf, for which the latter becomes responsible to make regular payments for the usage of the equipment. At the end of a lease the business has the option to A) purchase the equipment outright; B) continue to lease it; or, C) return it to the seller, all depending on the conditions of the lease. This varies from other methods of equipment financing that ultimately result in owning the equipment and being responsible for its sale when it no longer meets its original needs.
Why do businesses lease?
Leasing can be an easy and beneficial way to acquire the equipment you need for your business. Every business is different, and so are their financial needs. The flexibility of equipment leasing can provide a unique set of advantages, the top three of which are:
- improved cash flow;
- income-tax benefits;
- accounting for technological changes.
Cash flow: A key benefit of leasing is the fact that it helps you conserve your working capital and manage your cash flow. For those who don’t have enough cash to purchase equipment outright, or those wishing to keep such reserves available for other operating costs, leasing is an ideal way to obtain new equipment without putting a lot of money upfront. Leasing helps keep your bank lines and cash reserves on hand for business expenses such as inventory and payroll, even purchasing a new building. Another benefit is that you know exactly what your monthly equipment costs will be, making it easier to budget.
Income-tax benefits: Leasing can also save you money on the tax front. Most financial partners will offer what are called true tax leases or plans that allow you to take advantage of Section 179 which can save you major tax dollars. We’ll go into more detail on these later.
Technological changes: The beautiful thing about leasing is that you have options. Again, at the end of your lease term you have the option to purchase the equipment, continue to lease it or return it and upgrade to newer equipment. This can be incredibly beneficial to your business because it gives you a mechanism for dealing with equipment obsolescence. In an industry with rapidly changing technologies, leasing can be ideal in terms of facilitates upgrading to the latest equipment without the hassle of remarketing your old machines. Just turn them in and move on.
The process usually begins with a credit application from your financial partner for the transaction. Leasing approvals and terms are typically based on factors such as the strength of your personal credit, cost of the equipment, your time in business, desired length of term and business needs. To ensure that the approval process goes as quickly as possible, be prepared by having your financial information up to date and ready to share. Depending on your credit status (in particular, challenged credits and start-up companies), the financial partner may need to ask for items such as financial statements, tax returns and/or bank statements to issue an approval.
After an approval is given, your financial partner will work with you to determine what type of lease structure will be best for you. A number of items will factor into the lease structure you choose.
Equipment cost and type: The equipment you choose will play a major role in determining the course of your lease. How much does it cost? What is its useful lifespan? How often does the technology change? How long will it meet the needs of your business?
As an example, say you decide to purchase an automatic screen-printing press. This type of equipment is fairly stable with an average lifespan of 10-15 years. It also costs a little more than other types of equipment: say $25,000 - 35,000 for starters. Given these conditions, it may make sense to choose a relatively longer lease term of 48-60 months giving you more time to spread out the cost and lower your monthly lease payments.
Another example would be the acquisition of digital equipment. Let’s say you decide to purchase a digital printer/cutter. As we all know, digital technology is changing rapidly, therefore this type of equipment faces more issues with obsolescence. There are two questions to ask yourself: 1) What are your technological needs going to be in 18-36 months? 2) What new technology/equipment will be available over those 18-36 months? The answer? Since you can’t predict the future it makes sense to choose financing that will allow you to be flexible and respond to anticipated changes in technology. Based on that concept, it makes sense to keep terms on this type of equipment shorter, giving you the ability to keep abreast of technology. Ideally, you’d want to select a 24-36 month term with the option to upgrade to newer technology at any point in time during the lease.
Leasing structures and purchase options: When writing your lease agreement, your financing partner will help you determine the structure and purchase option that will be best in your situation. One of the most common purchase options is the FMV (Fair Market Value) lease. In this instance, the equipment can be purchased for a pre-determined percentage of the equipment cost, such as 10-20 percent. This percentage can be capped at a certain amount to ensure that a fixed percentage is paid at the end of term. Another choice is a $1 purchase option. Your choice will have a direct impact on your monthly payments. The FMV purchase option helps you keep your regular payments low, saving a predetermined balloon payment for the end of term that you can either pay, if you want to keep the equipment, or return the equipment. With the $1 purchase option, your payments will be higher but your purchase at the end is one simple dollar and the equipment is yours.
Because leasing can be inherently creative, your lease terms can be structured to meet your specific business needs. Many leasing companies offer special programs such as learning-curve leases or step-up payments that are great for companies adding a new component to their business. These structures allow you to reduce payments at the beginning of the lease, giving you more time to get familiar with the equipment and start making profits with it before regular payments begin.
Leasing can also address seasonality in a business. For example, if you have a traditionally slow period in your business, your leasing partner can structure your lease with reduced payments for those particular months, then ramp back up during your busy season.
Tax Savings: These purchase options also influence your eligibility for certain tax-saving benefits. Your lease can be written as a true tax lease which means you are able to deduct your monthly payments. This is typically structured with the FMV purchase option. On the other hand, if you’re looking for a more immediate deduction, you can consider taking the Section 179 deduction. Section 179 is part of the IRS tax code that allows businesses to write off their equipment purchases up to a certain dollar amount in one calendar year. In 2007, the limit is estimated to be (the final number being unavailable at press time) $112,000. The key to this deduction is that the equipment must be purchased at the end of the lease. This is typically done with a $1 purchase option or a set purchase option without the ability to return the equipment at the end of the lease term. Be sure to check with your accountant or tax professional to see which option will work best for your business.
Go for it!
As you’ve seen here, equipment leasing can be a very efficient way to acquire new equipment. It’s fast, flexible and can be beneficial to your bottom line. The key is to work closely with your leasing partner to create a program that is matched to your business needs. With the right equipment obtained via the right lease-purchase plan, you’ll be well on your way to expanding your business and increasing profits.