Leasing Technology Assets

Maximize your working capital.

As the U.S. economy picks up steam, investment in IT equipment and software is expected to rise appreciably in the next 12 to 18 months as companies begin to upgrade and replace aging hardware and software. One of the most popular funding methods for IT expenditures is equipment leasing. According to Information Week (9/1/03), the IT leasing industry posted $23.8 billion in volume last year and expects to grow 6.5 percent annually. What makes IT leasing such an attractive and popular alternative to cash or bank financing?

Reasons To Lease
The most important reason to lease, or finance in general, is to conserve cash for vital working capital needs. The old adage “long-term assets should be funded by long-term liabilities” is based upon the principle that working capital is the fuel that funds the growth of small companies, and maximizing it is critical to operating success.

Lease financing does not utilize a portion of a bank’s line of credit. Often a bank line of credit is limited to a collateral formula based on the company’s accounts receivable and inventory values. If a company funds an asset under its line of credit, then availability to borrow is reduced.

True leases will often have significantly lower monthly payments than loans or finance leases. True leases (a.k.a. operating leases) are for when the lessee requires the asset for a specific useful period and then relinquishes control at the end of the lease. Examples are cars, aircraft and mainframe computers. In true leases, the lease payment reflects only the “rental value” of the asset as opposed to an amortization of the purchase price, thereby lowering the lease payment. However, should the lessee later desire to purchase the asset at the end of the lease, the purchase price would be fair market value.

Working capital is the fuel that funds the growth of small companies, and maximizing it is critical to operating success.

Finance leases operate similarly to installment loans, where the lessee has either an obligation or a high probability of acquiring the asset at the end of the lease for a fixed dollar amount, and therefore pays a portion of the ownership cost each month.

Leases generally advance 100 percent of the value of the asset as opposed to bank loans. Saving 20 percent on a loan down payment means extra cash available for the business.

True leases are “off balance sheet” transactions, meaning a firm’s obligation under a lease arrangement is not recorded as debt. This is important for leveraged or high growth companies seeking to stay within bank covenant agreements. Finance leases, similar to loans, are required on the balance sheet.

Captive leasing companies, including those at IBM, HP and Dell, were created to move product, and, in leaner times, offer more attractive lease rates than other IT lessors and banks. Similar to the zero percent car financing incentives, captive IT lessors can be more aggressive on price as inventories rise.

Top Eight Reasons
To Lease

  1. Conserve cash for vital working capital needs.
  2. Lease financing does not utilize a portion of a bank’s line of credit.
  3. True leases often have significantly lower monthly payments than loans or finance leases.
  4. Leases generally advance 100 percent of the value of the asset as opposed to bank loans.
  5. A firm’s obligation under a true lease arrangement is not recorded as debt.
  6. Captive IT lessors can be more aggressive on price as inventories rise.
  7. Right now, fixed rates are low and very competitive.
  8. A lease creates another creditor/banking relationship.

Now is a great time to lock in long- term fixed rates. As home owners know, fixed rates are low and very competitive. Once the economy picks up, economists expect short-term and long-term rates to rise.

A lease creates another creditor/banking relationship. It is healthy for companies to spread their credit risk to more than one lending institution. Satisfied lenders will provide a competitive pool for future banking opportunities. As Ben Franklin said, “The best credit comes from a well-paid debt.”

Leasing May Not Be Right for Everyone
As enumerated above, leasing is an excellent funding source for fast growing and leveraged companies. However, in several cases, leasing may not be the right solution. The following are some examples.

With the bank prime rate at four percent (as of December 2003), short-term money may be a less expensive alternative to a higher rate fixed loan or lease rates. Provided the company has ample additional room to borrow, bank borrowing may also save the hassle of additional paperwork, legal expenses and a personal guarantee.

Bank covenant agreements sometimes prohibit lease transactions without the bank’s consent.

While true leases have lower monthly payments than loans, beware of the purchase option clause at the end of the lease. A true lease must have a fair market value (FMV) purchase option. If there is a ready market for the asset, the lessor may ask the borrower to pay a “market price,” potentially well above what the borrower was willing to offer. True leases for trucks, autos, cylinders and other items with ready markets should be reviewed carefully if an eventual purchase is contemplated.

The new tax law allows small businesses to immediately deduct up to $100,000 of current year qualifying fixed asset purchases. If an asset were purchased via a bank loan or finance lease, this tax deduction would be allowed. Under a true lease, only the monthly lease payments would be deductible for tax purposes.

Leases may sometimes be clad with fees, deposits and maintenance requirements, which may partially offset an attractive lease rate. Borrowers are advised to read the fine print of all borrowing documents.

Throughout the past three decades, leasing has become a popular financing vehicle. As you consider your firm’s next IT equipment or software purchase, consider leasing as a financing option.

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Scott Ehrnschwender Meet the Author
Scott Ehrnschwender is GAWDA’s technology consultant and president of Efficiency Associates Inc. in Terrace Park, Ohio.