Equipment leasing is when a business obtains the use of machinery, vehicles or other equipment on a rental basis. This avoids the need to invest capital in equipment. Ownership rests in the hands of the financial institution or leasing company, while the business has the actual use of it.
Small business equipment leasing programs provide many benefits to business owners compared to the outright purchase or regular financing of equipment, such as minimal upfront costs, tax savings and minimal risk of equipment becoming obsolete.
How it Works
The business owner who is leasing the equipment is the lessee. The bank or financial institution that is renting the equipment to you is the lessor. Legal title to the equipment stays with the lender, but you have the right to use the equipment according to the terms of the lease in exchange for regular payments made over a contracted period of time. Just like with a bank loan, you need to have good credit and prove your ability to repay the lender.
What can you Lease?
Many types of equipment can be leased. Most of the time when it comes to small businesses, leasing usually pertains to office equipment or heavy machinery. The office equipment can be anything from cubicles and furniture to computers, phone systems, fax machines and copy machines. In addition, some small businesses lease their company cars since car values quickly depreciate. Businesses that lease their company cars often update their vehicles within a couple of years, or tailor leases to their specific needs.
There can be several reasons to lease equipment rather than buy it. These benefits include:
- Minimal upfront costs
- Tax savings
- Less hassle
- Minimal risk of the item becoming obsolete
Minimal Upfront Costs
One of the biggest reasons to lease business equipment is that it offers fairly minimal upfront costs. Leasing seldom requires a down payment, and leasing payments are generally lower than mortgage-type payments. This is because they are not usually subject to high interest payments, and are usually spread over longer periods of time. Unlike bank loans that may require a substantial down payment, two advance payments are generally all that are required at the beginning of a lease. This lets you keep your capital in the bank while making important investments in your business.
Many businesses discover that after taxes they save money purchasing leased equipment. Depending on how your lease is structured, you may be able to fully deduct lease payments as a business expense, as opposed to depreciating the value of the equipment as if it were a capital expenditure.
Leasing equipment is not as difficult as trying to obtain another form of financing. For equipment purchases under $100,000 you typically will not have to provide financial statements, tax returns or a business plan. The form you fill out is usually a simple one-page form that is similar to filling out a credit card application. The approval process is also rather quick as compared to a loan which can take days or even weeks before you are finally approved for the financing.
Minimal Risk of the Item Becoming Obsolete
Some companies lease business equipment as a way to protect against obsolescence. Leased equipment can be updated on a regular basis as needed and the old equipment can simply be returned to the leasing company.
Types of Equipment Lease Financing
A business that will be leasing office equipment is most likely going to use an operating lease (also known as a true lease, tax lease or fair market value lease). Business equipment that will better stand up to the test of time is usually leased in the form of a finance lease (also known as a capital lease, conditional sales lease or dollar buy out lease).
An operating lease is generally a fairly short-term lease and is used to cover equipment that needs to be updated on a regular basis. Computers, fax machines and telemarketing phone equipment generally fall into this category. Operating leases usually do not span the full expected life of the equipment.
At the end of the lease, you can choose to walk away from the equipment or purchase it at fair market value. Payments on true leases generally tend to be lower than those on finance leases. This is because lessors have the opportunity to resell the equipment when the lease ends.
One of the main benefits of operating leases is that you may be able to fully claim lease payments as deductions for tax purposes. In contrast, the IRS considers finance leases little more than installment purchase plans. As a result, although finance leases let you spread your payments over time, they are not tax advantaged in the way operating leases are.
A finance lease works best if you intend to keep the equipment at the end of the lease. The main advantage of this type of lease is that it gives you the option to purchase the equipment for a nominal fee, usually $1.00. Payment terms on finance leases tend to last close to the expected useful life of the equipment.
Finance leasing is almost always the best idea when the same equipment will be used for a long period of time, say five years or longer. Finance leases are almost exclusively long term leases, unless the business doing the leasing opts for higher payments for a shorter period of time.
When to Consider Equipment Leasing
Equipment leasing should be considered when any the following conditions occur:
- There is a high risk that equipment will become obsolete before the end of its useful life
- The equipment will be needed only for a short period of time
- Capital resources need to be preserved
- Technical, administrative or other non-financial equipment not internally available can be more easily secured from a leasing company
- High interest rates must be paid for borrowing money
- The tax benefits resulting from the equipment ownership cannot be used
- The equipment will have a poor market value at the end of its term use