Businesses looking to acquire assets in the most cost-effective way must weigh the pros and cons of leasing versus buying. Small businesses, especially, often favor leasing equipment as an alternative financing arrangement to acquire the use of assets without having to raise capital. Typically, leasing is a convenient option to obtain all types of equipment, from manufacturing machinery and office furniture to motor vehicles and computers.
What Is a Lease?
A lease is a long-term agreement to rent equipment, land, buildings or any other asset. By making periodic payments to the owner or lessor, you’ll receive most of the benefits of ownership.
Basically, you’ll see three main types of leases: the financial lease, the operating lease, and the sale and leaseback. The most common, the financial lease, is usually written for a term not to exceed the economic life of the equipment. Sometimes referred to as a maintenance lease, the operating lease can usually be canceled under conditions detailed in the lease agreement. This is the type most often used to lease computer equipment.
With a sale and leaseback agreement, the asset’s owner sells it to another party and simultaneously leases it back to use it for a specified term. That allows the owner access to money tied up in the asset to use for other purposes.
Advantages of Leasing Equipment
The obvious advantage to leasing is acquiring the use of an asset without making a large initial cash outlay. Compared with a loan arrangement to purchase the same equipment, a lease usually:
- Requires no down payment, while a loan often requires 25 percent down.
- Requires no restriction on a company’s financial operations, while loans often do.
- Spreads payments over a longer period (which means they’ll be lower) than is permitted by loans.
- Provides protections against the risk of equipment obsolescence, since the lessee can get rid of the equipment at the end of the lease.
- Offers some tax benefit, as payments are deductible operating expenses.
- Offers access to the leasing firm’s considerable knowledge about the equipment and expert technical advice.
Disadvantages of Leasing
Leasing often costs more because you lose any tax advantages connected with ownership of an asset. Leasing may not cost more if you aren’t eligible for those tax benefits because you don’t have enough tax liability.
Additionally, because you don’t own the asset, you will lose its economic value at the end of the lease term. That is one reason why you should research the estimated salvage value of the asset, which may influence your decision to lease or buy.
Since you can’t cancel a lease agreement, if you were to end an operation that used leased equipment, you might still have to pay as much as if you had used the equipment for the full lease term.
Make Sure You Get the Best Lease for Your Business
Because a lease is a legal document with definitive commitments, you want to make sure you completely familiarize yourself with all of the conditions before making that commitment. Agreements vary, obviously, but the following are some of the major provisions that a lease agreement will typically include:
- Payment amount.
- Term of agreement.
- Renewal options.
- Cancellation penalties.
- The specific components of the financing agreement.
- Responsible parties for maintenance and taxes.
- Disposition of the asset at the end of the term.
- Schedule of the value of the equipment for insurance and settlement purposes in case of damage or destruction.
- Special provisions.
Best advice? Do your due diligence. Make sure you research the lessor’s financial condition and reputation. Confirm that the equipment is exactly what you need, that the term fits your situation and that the lease agreement works for what you need. Remember, once you sign that agreement, it’s almost impossible to redo it.