Equipment Leasing FAQ

  1. Who uses Equipment Leasing?
  2. How complicated is Equipment Leasing?
  3. Is Equipment Leasing right for me?
  4. What are some of the benefits of Equipment Leasing?
  5. What is the interest rate on a lease?
  6. Are there different types of Equipment Leases?
  7. What are the up-front costs for a lease?
  8. Is there a minimum equipment value requirement for a lease?
  9. What financial and credit information is required?
  10. What are the benefits of an independent leasing company vs. vendor financing options?
  11. Why choose a 10% or fair-market-value purchase option vs. a nominal $1, $10, or $100 buyout at the end of the lease?
Who uses Equipment Leasing?

Any company, organization, association or municipal entity (city, county, state, and federal) can lease equipment. Leasing is the one of the most popular ways of financing equipment in business today. It is estimated that about 80% of all U.S. businesses lease at least some of their equipment. The list of companies using leasing ranges from the Fortune 500 to the mom-and-pop shop at the corner. Choosing to lease equipment is especially practical for startup companies, businesses that can’t afford to purchase equipment, and companies that don’t want to tie up a lot of their available capital in the purchase of equipment.

 

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How complicated is Equipment Leasing?

Equipment Leasing is relatively simple and easy. Either the vendor of the equipment offers an “in-house” leasing option directly, or the lessee identifies the required equipment and the vendor, and an independent leasing company will purchase the equipment, retain ownership of it, and let the lessee use the equipment through a leasing agreement.

 

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Is Equipment Leasing right for me?

It depends. Do you make money by using the equipment or by owning it? If your operation benefits from the use of equipment and you can preserve your cash or use it for other business needs, then leasing might be for you. You can also check if any or all of the benefits from leasing (see below) are relevant to you. But in any case, before deciding for or against leasing, you should discuss your individual situation with your CPA.

 

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What are some of the benefits of Equipment Leasing?

There are a number of reasons why companies might prefer leasing over buying:

  • Better cash flow and conservation of cash: Leasing is 100% financing that can roll equipment cost, delivery, installation, maintenance & taxes into one single monthly payment, and your working capital is not tied up in equipment. Instead it can be used to grow the business. By spreading the expense over time, the business can benefit and profit from the use of the equipment instead of from ownership.
  • Preservation of credit: Leasing does not create long-term debts or liabilities. Therefore it does not show as debt on the financial statement. Consequently your borrowing capacity remains untouched, and your credit remains available for other investments.
  • Lower monthly payments and fewer budget constraints: Lease payments are typically lower than those of other financing methods. You can also select a monthly payment schedule in line with your budget instead of having a big capital expenditure for an outright purchase. In fact, you will not need to spend money up-front on a purchase that you then have to earn back through the use of the equipment, because you can actually use the equipment to earn money, while making the monthly payments.
  • Tax Benefits: Depending on the type of lease, the payments are usually a pre-tax business expense and as such can be up to 100% tax deductible. Also, if your company cannot use the depreciation tax shield, it could also make sense to have the equipment owned by someone else (i.e., the lessor) who can. However, you should always consult your CPA before making any decision.
  • Elimination of Technological Obsolescence: With new technology becoming available, leasing allows you to upgrade to the latest technology that you helps you increase quality and productivity and best fits your business needs. By leasing, you won’t be taking the risk of getting stuck with obsolete or dated equipment.

 

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What is the interest rate on a lease?

Leasing companies will typically not quote an “interest rate” as you would expect to see with traditional loans or credit lines. As a lease is not a loan, there is really no “interest rate”. It is more like a rental fee, with the monthly payment amount being determined by the nature and cost of the equipment, the duration of the leasing period, the credit history of the lessee, and who gets the tax benefits (i.e., the lessor or the lessee). However, one has to remember that leasing rates for the same piece of equipment can vary considerably between different leasing companies and between different lessees. In general, the monthly payments with a lease are typically lower though than the monthly payments for financing a purchase.

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Are there different types of Equipment Leases?

Yes. For example, one type is a Financial Lease (a.k.a. Capital Lease). This is a long-term, non-cancelable lease for equipment the lessee intends to use for a longer period of time. With this arrangement, the lessee has the obligation to insure and maintain the equipment. This type of lease is generally used for major equipment that is rather expensive.

Another type of lease is an Operating Lease. It is a short-term lease with cancelable terms, and the leasing company bears the obsolescence-risk. This type of lease is usually preferred when a company needs the equipment only for a short period of time. Usually the lessee can also cancel this type of leasing arrangement with prior notice and without significant penalties.

Other leasing arrangements are usually some form of a hybrid with elements from both, financial and operating leases. Those leases are usually based on the individual leasing programs the different leasing companies offer. You might come across a full-service lease (in which the leasing company – not the lessee – is responsible for insurance and maintenance of the equipment) or a leveraged lease (where the cost of the leased piece of equipment is financed by issuing debt and equity claims against the equipment and against future lease payments).

 

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What are the up-front costs for a lease?

The up-front costs on a lease are typically the first and the last monthly lease payments. However, these payments are applied to the lease payment schedule. In addition, a small underwriting or documentation fee is typically charged for the preparation/delivery of the lease documents and the UCC-1 lien filing in the appropriate state.

 

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Is there a minimum equipment value requirement for a lease?

The short answer is no. However, most leasing companies have a niche with which they are comfortable. A small ticket for leasing companies is any equipment purchase up to $100,000. A medium ticket is up to $5 million, and large ticket is greater than that. Leasing companies typically will specialize in one of these three categories. Major finance companies will most likely have divisions for each of these categories and may also have further breakdowns for the different types of equipment.

 

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What financial and credit information is required?

Requirements typically depend on the size of the transaction and the lessee. Most leasing companies will at minimum require the Social Security number of the personal guarantor and/or the company’s Federal Employment Identification Number (FEIN). Physicians and dentists will also be required to show evidence of their professional capacity. In general, Dun & Bradstreet PAYDEX scores (70 and above) as well as FICO credit scores (650 and above) play an important role in evaluating a leasing application.

While leasing companies rely on this information, the scores are not necessarily the only deciding factors. Time in business, cash reserves, and management experience will also influence the decision. Good leasing companies should discuss with the applicant all aspects of the application and point out any derogatory information, as well as offer suggestions on how to correct this information. For lease transactions in excess of $100,000, lessees will typically be required to show their financial statements for the past two or three years. Many leasing companies require a minimum of three years of operation. Personal guarantees by the principals and in some instances, the spouse, are not uncommon. In some cases, audited financial statements may also be required.

 

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What are the benefits of an independent leasing company vs. vendor financing options?

Vendor leasing companies only represent the manufacturer of the leased equipment. Often – but not always – they can offer lower leasing rates than an independent third party leasing company. A manufacturer’s leasing company has a high degree of control should there be a need to change out or upgrade the equipment during the term of the lease. A disadvantage to doing business with a vendor leasing company is that changes made during the lease term could be more costly, and no viable alternative would be available other than the original manufacturer’s equipment. Independent leasing companies offer a full range of leasing options that could better meet the lessee’s objectives. One of those options – and a major benefit at that – is the unrestricted access to a competitive vendor marketplace.

 

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Why choose a 10% or fair-market-value purchase option vs. a nominal $1, $10, or $100 buyout at the end of the lease?

The IRS guidelines on leasing call for a buyout option of at least 10% in order to be considered a true lease. With anything less than 10%, the IRS considers the transaction a conditional sale contract, and in case of an audit, the tax write-off could be lost. When people choose the dollar buyout at the end of the lease they typically just do not want to pay a large sum at the end of the lease. Sometimes lessees might also deduct the payments as a rental expense even though the lease arrangement is considered a conditional sale contract. However, that will put them at risk of getting into trouble with the IRS.

 

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