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Equipment Leasing: A Guide for Business Owners

Equipment Leasing: A Guide for Business Owners
Credit: Olivier Le Moal/Shutterstock

Need new equipment but can't afford to buy it outright? Equipment leasing might be for you.

Equipment leasing is a popular way for businesses of every size to affordably keep technology and equipment up to date. Because most leases do not require a substantial down payment, leasing enables you to hold on to your cash and invest it in other areas of your business. Many equipment leases also allow you to trade in your old equipment, an additional feature that makes equipment leasing especially appealing to companies who would otherwise end up with obsolete equipment. 

Some equipment leases also qualify you for tax credits. Depending on the lease, you may be able to deduct your payments as a business expense by taking advantage of Section 179 Qualified Financing. Despite a recent decrease in the deduction limit from $500,000 to $25,000, Section 179 is still a preferred financial strategy for a wide range of businesses. 

Before you start the process, it's important to answer the following questions:

  • What is your monthly budget? Leasing offers substantially lower monthly payments in comparison to purchasing. But it still has to be factored into your monthly cash flow.
  • How long will the equipment be used? For short-term use, leasing is almost always the most cost-effective way for businesses to go. But if you're using the equipment for three years or more, a loan or standard line of credit may be more beneficial than a lease.
  • How quickly will the equipment become obsolete? Technology is more likely to become outdated more quickly than other types of equipment. Consider this before deciding whether a trade-in makes sense for you.

Editor’s Note: Considering an equipment leases for your business? If you’re looking for information to help you choose the one that’s right for you, use the questionnaire below to have our sister site, BuyerZone, provide you with information from vendors for free:

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The range of equipment that qualifies for a lease is practically limitless. But there are a couple of conditions:

  1. Purchase price – Equipment leases enable businesses to obtain equipment and machinery that has a high dollar value. This ranges from costly single items like heart monitors and extraction machinery to smaller items needed in bulk like kiosks, software licenses and telephones. For this reason, it's uncommon to find a lease agreement for purchases under $3,000, and many large lenders have a minimum purchase of $25,000 to $50,000. 
  2. Hard assets – The equipment you lease has to be considered a "hard asset." In other words, this means anything that could be listed as personal property and not permanently attached to real estate. Soft assets like training programs and warranties do not qualify for lease programs. 

The profitability of any equipment purchase is largely determined by the method of finance, making this one of the most crucial steps in the buying process. Yet while an equipment lease often represents one of the most lucrative options, it's not the only alternative. Depending on your cash flow, credit score and accounts receivable, you may be able to find a better deal.

While many businesses benefit from equipment leasing, there are some instances where an outright purchase may be a more cost-effective option. In short, the determining factors used to compare purchase and lease include:

  • Purchase price
  • Amount financed
  • Annual depreciation
  • Tax and inflation rates
  • Monthly lease costs
  • Equipment usage
  • Ownership and maintenance costs

Generally speaking, an equipment lease is ideal for equipment that routinely needs upgrading — for instance, computers and electronic devices. A lease gives you the freedom to obtain the latest machinery with a low upfront cost and provides reliable monthly payments that you can budget for. At the same time, this low-cost payment schedule also provides a wider range of options for many businesses in terms of the equipment accessible to them. This can make it possible to afford equipment that would otherwise be too costly to purchase.

Of course, leases require paying interest, which can add to the overall cost of a machine over time, making it more expensive than if it was purchased outright — especially if you end up purchasing the equipment at the end of the lease. In addition, some lenders enforce a specific term length which can further add to the cost if the length of the lease extends beyond your necessity. In this scenario, you could get stuck with a monthly payment as well as storage costs associated with unused equipment.

Purchasing an item outright is the other option, and one often selected by those who need enhanced customizations built into a machine. When you own a piece of equipment, you can have it modified to suit your exact needs; this isn't always the case with a lease. Similarly, some buyers report a wider set of options when compared to a lease as they are not bound by the limitations of a lessor. 

Purchases also enable you to get any issues resolved immediately, not having to wait for approval from the leasing company to get a replacement part or repair. And in addition to the depreciation tax benefits available through Section 179, you also stand to make some money back by reselling the equipment when it's no longer of use to you. 

But like a lease, purchases have their drawbacks. The biggest is obsolescence; with a purchase, you're stuck with the outdated machinery until you can buy new. Given the competitiveness of the marketplace and the availability of tax incentives, this is often enough to dissuade many buyers from purchasing outright. Add to that all of the expenses associated with maintenance and repairs, and a purchase can represent a major investment. 

By some estimates, businesses will budget between 1 percent and 3 percent of sales for maintenance costs. However, this is a rough estimate, with actual costs determined by the equipment itself, service hours, equipment age, quality and warranty.

A purchase isn't the only alternative to a lease. In fact, it's not even the most common. Loans, lines of credit and factoring services are popular means of financing a large equipment purchase as well.

Similar to a purchase, loans provide more ownership of the equipment. With a lease, the lessor holds the title to any equipment and offers you the option to buy it when the lease concludes. In comparison, a loan enables you to retain the title to any of the items you purchase, securing the purchase against existing assets. 

  • Important to note: A loan places more importance on your business's credit score. This can make it difficult for new and small businesses to get approved. For this reason, loans are primarily used by established businesses with excellent credit, qualifiers that enable them to get the best terms.

Unfortunately, terms are simultaneously some of the major drawbacks of a loan. Unlike a lease, which provides fixed-rate financing, a loan or line of credit may fluctuate throughout the loan term. This can make budgeting problematic depending on the size of the loan. In addition, banks and other lenders often require a much larger down payment — 20 percent of the total cost of equipment by some estimates.   

In addition to loans, factoring is an alternative way to purchase costly equipment and is often faster than the process of applying for a loan. By leveraging your accounts receivable, you can quickly turn outstanding payments into cash by selling these invoices to a factor. Often paying up to 90 percent of the total value of your accounts receivable (depending on the credit worthiness of your customers), factoring is an ideal alternative to leasing and loans for startups and small businesses. 

Funding is usually available in a matter of days. This makes factoring a popular resource for smaller manufacturing operations, the transportation industry and businesses that routinely handle contracts that have a fast turnaround.  

When applying for a lease, you can expect the process to include the following steps:

  • Step 1 – You complete an equipment-lease application. Be sure you have financial data available for both the company and its principles as this may be required upfront or after initially completing the application.
  • Step 2 – The lessor processes your application and notifies you of the result. This usually happens within 24 to 48 hours of submitting the application.
  • Step 3 – Once approval is received, you must review and finalize the lease structure, including monthly payments and the fixed-rate APR. After the review, you'll sign the documents and resubmit them to the lessor, typically including the first payment.
  • Step 4 – When the lessor has received and accepted the signed documents and first payment, you are notified that the lease is in effect and that you are free to accept delivery of the equipment and commence any training necessary.
  • Step 5 – Funds are released within 24 to 48 hours directly to you or the manufacturer you are purchasing from.

Some lessors may not require financials and/or a business plan for applications on dollar amounts from $10,000 to $100,000. For financing on $100,000 to $500,000 (and up), you should expect to provide complete financials as well as a business plan.

Operating lease

There are two primary types of equipment leases. The first is known as an operating lease. In short, this structure is provided by a lessor to allow a company to use a particular asset for a specific period of time without ownership. The lease period is usually shorter than the economic life of the equipment. So at the end of the lease, the lessor is allowed to recoup additional costs through resale.

Unlike an outright purchase or equipment secured through a standard loan, equipment under an operating lease cannot be listed as capital. It's accounted for as a rental expense. This provides two specific financial advantages:

  1. Equipment is not recorded as an asset or liability
  2. Equipment still qualifies for tax incentives.

Rates that dealers offer are all over the board, but in general, the average APR for an operating lease is 5 percent or lower. Average contracts extend for from 12 to 36 months.

With the prevalence of leasing, new accounting regulations from the Financial Accounting Standards Board (FASB) require companies to reveal their lease obligations to avoid the false impression of financial strength. In fact, according to recent reports, all but the shortest-term equipment leases must now be included on balance sheets. So while leased equipment does not have to be reported as an asset under an operating lease, it's far from being free of accountability.

Finance lease

The second type of equipment lease is a finance lease. Sometimes known as a capital lease, this structure is similar to an operating lease in that the lessor owns the equipment purchased. But it differs in that the lease itself gets reported as an asset, increasing your company's holdings as well as its liability. 

Commonly used by large companies such as major retailers and airlines, this setup provides a unique advantage as it allows the company to claim both the depreciation tax credit on the equipment as well as the interest expense associated with the lease itself. In addition, the company may choose to purchase the equipment at the end of a finance lease.

Given the financial edge this provides, the APR for a finance lease is higher and often double that of an operating lease. Standard interest rates currently hover between 6 percent and 9 percent. Average contracts range from 24 to 72 months.

Lessee responsibilities

There are a number of additional responsibilities that can result in expenses above and beyond the cost of your monthly lease payment. These items typically include:

  • Insurance – Average estimates for liability insurance range from $200 to $2,200 annually, with many businesses reporting costs of $1,000 or less.
  • Extraneous costs – Depending on your lease structure, you may be held liable for some maintenance and repairs. Extraneous costs can also include any legal fees, fines and certification expenses. 
  • Return of equipment – This includes transportation and shipping costs.
  • Fees – Read your contract carefully. Fees can be assessed for everything from a one-time "documentation fee" (sometimes as much as $250) to late-payment fees which can run as little as $25 or as much as 15 percent of the amount overdue.

Given the costs and considerations addressed in the sections above, it's essential to compare a number of equipment lease providers to ensure you get the best rate. Before beginning your search, it's important to familiarize yourself with the three different types of equipment finance providers and the benefits each can provide. These include:

  1. Broker – Similar to an insurance broker, a lease broker will serve as an intermediary between you and any prospective lessors. The broker will present you with the offers and submit your requests for financing, handling much of the paperwork for you. Brokers represent only a small segment of the leasing market, and their service does not come cheap. Brokers reportedly charge 2 percent to 4 percent of the cost of the equipment to negotiate a deal. The benefit of using brokers is realized in their extensive relationships. Often specific to a particular industry, they specialize in obtaining a wider range of equipment, sometimes at a better price than would normally be made available through standard channels.  
  2. Leasing company – This is often the subsidiary leasing arm of a manufacturer or dealer. Also known as a captive lessor, a leasing company's sole aim is to facilitate leases with its parent company or dealer network. For this reason, you will usually only deal with a leasing company when working directly with a manufacturer. 
  3. Independent lessor – This type encompasses all third-party lease providers. Independent lessors include banks, lease specialists and diversified financial companies that provide equipment leases directly to a business. They differ from a leasing company in that they typically specialize in the re-marketing of equipment, a skill that enables them to group products from multiple manufacturers and offer a more competitive APR. 

The best advice on choosing a quality lessor is to examine them as closely as they're examining you. Give preference to those that are willing to work with your business as a partner. This may be represented in the level of background and experience they have in relation to your line of business, or it may be the quality and quantity of positive references they're willing to provide. It's worth noting that some of the fees mentioned under lessee responsibilities can be covered or waived depending on the lessor, in particular, application fees and late fees (at least on the first late payment).

Also take time to research:

  • Business information – Including payment history, credit history, business summary, corporate relationships, financial statements and any public filings.
  • Pending litigation – Search public records for any notices of pending litigation.
  • Payment system – Is it easy, or does it require mountains of paperwork?

As you narrow down the list of prospective lessors, here are a few final questions that can help you determine which one is best suited to your particular business needs:

How much money is required up front? 

Lease financing often provides 100 percent of the dues required for an equipment purchase. Loans do not, often requiring up to 20 percent of the total as a down payment. If a down payment is required, you may consider reassigning capital to cover any upfront costs. 

Who takes advantage of the tax incentive? 

Under a loan structure, your company can claim depreciation. However, you will have to provide a down payment and be responsible for a higher rate of interest. Under a lease, the lessor claims depreciation. In exchange, they offer a lower APR – often half that provided through a loan. If the depreciation credit is important to you and you still want to lease, ask about the availability of finance or capital leases.

Are the financing terms flexible?

Leases are often viewed as the most flexible financing options, especially in comparison to loans. Depending on the structure of the lease, you can opt to start with low payments and increase as time goes by (known as a "step-up lease"), defer payment to give yourself an extra window before the first payment is due, and even add additional equipment onto an existing lease under a "master lease" structure.

Editor’s Note: Considering an equipment leases for your business? If you’re looking for information to help you choose the one that’s right for you, use the questionnaire below to have our sister site, BuyerZone, provide you with information from vendors for free:

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