Many companies regularly consider leasing as an option when acquiring new light- and medium-duty vehicles but don’t always think of leasing when they need to acquire new equipment.
“Equipment leasing offers similar benefits to fleet leasing, but also benefits the typical fleet lessee may not be aware of,” says Randy Hicks, executive vice president of Nations Equipment Finance of Norwalk, Conn.
“Leasing equipment allows your company to preserve capital,” Hicks says, adding that purchasing equipment in a lump sum ties up bank credit lines that could be used to invest in other areas of the business.
A stronger balance sheet is another benefit, Hicks says. Similar to an operating lease for fleet, when companies lease their equipment, it does not appear on the assets or liabilities columns of their balance sheets. Instead, it is listed as an operating expense on their income statements.
Another issue to contend with involves the equipment’s future value and its potential technological obsolescence. Leasing allows the owner to simply return the equipment at the end of the lease term and update with newer technology.
Types of Leases
Equipment leases have three basic variables: the length of the lease (term), the payment and the buyout. Similar to fleet leases, equipment leases are a minimum of 12 months and are often written from 48 to 60 months.
There are two general types of equipment leases. The most common is an operating lease (or a true lease or tax lease). At the end of the term, the company has the option to renew the lease, return the equipment to the lessor or buy it for fair market value.
The second is a capital lease (or a finance lease) in which the equipment is amortized to a dollar buyout at the end of the term, at which time the company usually assumes the asset. The capital lease essentially acts as a lease to purchase and is used over financing because it offers 100% financing and no money down.
While the capital lease is counted on a company’s balance sheet, the operating lease is not.
How and When
Understanding how you will use the equipment will dictate the type of lease and terms.
In the world of construction and contracting, leases are often written based on the length of the job. “If you don’t think you’d need that equipment in five years, you probably want to lease because you can return it to the lessor and there’s still a portion of it that hasn’t been amortized,” Hicks says.
But if you want to keep the equipment, Hicks suggests a capital lease or straight financing to pay it off and own it.
For contracts or jobs lasting about a year, equipment rental is the better option, Hicks says.
Even though you think the situation warrants, steer clear of unusually long lease terms, which increase the chance that you’d break the lease — and breaking the lease will cost you.
While companies intend on leasing computers because of their future technical obsolescence, Hicks says that in reality, upgrading systems and moving data and software every three or four years is not an easy task. Instead of returning the computers to the lessor, companies would be smart to use a lease to write down the cost and buy them out at the end of the term. Then they can decide how long to keep the computers.
Unlike fleet leasing, companies leasing equipment don’t have the ability to adjust their amortization factor. It’s a fixed payment and fixed term, similar to a home mortgage.
And while fleet lessors may work with a good client to adjust a lease — if business changes push yearly mileage into penalties — equipment leasing is more rigid.
Lessees should also be aware of early lease termination policies. There is usually a termination value table in the lease that stipulates an early lease penalty, which could vary from 3% to 5% of total price, or 2% to 3% of the unamortized balance.
Hicks says the right to terminate a lease may not even be given contractually, especially from years one to three, as a protection against companies using an equipment lease for short-term financing. In this case, it’s up to the lessee to see what the lessor is willing to do — if anything.
Equipment leases do come with return conditions, and equipment lessees will be charged for excessive wear and tear.
An equipment lessee must maintain insurance on the equipment for the stipulated loss value in the lease. While this is a given in auto leases, it may not always be considered when leasing items such as computers.
Companies can take advantage of equipment leasing in other creative ways — such as refinancing — to lower payments and create cash flow, or generate a lump sum of working capital.
Hicks gives the example of a company paying $200,000 per month to a lender for fleet equipment that was financed three years ago.
An equipment leasing company could refinance the same equipment over the next five years and lower the company’s payment to $94,000 per month.The resulting $106,000 of monthly savings could be used to reinvest in the business, or the lessee could take a lump sum payment.
An equipment lessor can also facilitate acquisition financing by helping the acquiring company value the acquisition target’s equipment and structure a line of credit from a local bank secured by the accounts receivables and inventory.
Equipment lessors can also finance used equipment, Hicks says, which banks and OEM equipment vendors may shy away from.
A Case Study
Hicks outlines a real-life example of a construction company that wanted to expand its business — and used its existing truck fleet lease to help it get there.
Three years ago, the company leased a fleet of 35 Kenworth T800 trucks from a local bank for a 60-month term for $3.5 million in total and a monthly payment of $70,000.
The company wanted to upgrade old construction equipment and to get into excavating, which required financing additional heavy equipment pieces. The total funded amount for the new equipment was $4 million.
Hicks worked with the construction company to lease the new equipment as well as refinance the truck lease, which had a balance of 24 months and about $2.03 million.
In so doing, the lessor paid the local bank the balance on the trucks and funded the new total amount of about $6 million to the construction company. The structure of the new deal was again set at 60 months, which made the company’s total monthly payment $125,080 — about $55,000 more than the original monthly payments for the trucks.
“This proved to be very beneficial to the construction company’s business productivity,” Hicks says. “They now had more equipment, which allowed them to hire additional workers and generate more income for the company.”
Good to Know
Here are some tips to help you decide if equipment leasing will work
- Get a flexible payment structure to fit your business needs. If your business has a slow season, ask for seasonal payment plans.
- Consider a leasing program that provides for lease expiration at or near warranty expiration.
- With an operating lease, if you think you’ll keep the equipment after the lease term, ask for a cap on the purchase price, such as “fair market value (FMV) not to exceed 20% of the equipment’s cost.”
- Use your existing equipment to generate cash. With a sale and leaseback, a leasing company buys your existing equipment and leases it back to you. You get the cash that is locked up in your equipment while still continuing to use it.
- Refinancing your existing equipment with a capital or finance lease can lower payments by as much as 50%.
- Understand the fine print. Most leases contain a termination value schedule, detailing the amount that will need to be paid to terminate the lease.
- Don’t be afraid to ask for references when shopping for an equipment leasing company.