Adapted from content excerpted from the American Express® OPEN Small Business Network
Financing new equipment -- from computers to phone systems to capital equipment and other gear you need to run your company -- is a major issue for many small business owners. Leasing, instead of purchasing, can be a cost-effective option, particularly if you don't have the cash on hand, but need the equipment.
In fact, you might want to consider leasing even if you do have the cash to invest. By leasing, you might find that you can regulate your cash flow more effectively, because you have predictable, regular monthly installments as opposed to a single lump sum payment. Plus, leasing can help you avoid tying up lines of credit, or you might want to use the money for another area of your business.
- How leasing works
- Advantages and disadvantages of leasing
- Terms to look for in a lease
- When a lease is not a lease
When you sign a lease you are assigning the rights for the equipment to the lessor. The lease-holder owns the equipment and is making it available to you for your use in exchange for the lease payments you make. There are several ways to acquire equipment through leasing. Among the most common are the following:
- Select equipment yourself and then seek financing through a lessor. You locate a system from the vendor of your choice and then work out a leasing agreement for that system with the leasing company. In this scenario, you usually still get service and support for the system from the vendor, rather than the lessor.
- Select equipment by working with a retailer or manufacturer which offers leasing through its own subsidiary. Once a purchase price is established, your vendor will translate that into a lease payment based on the terms you've requested.
- Obtain equipment directly through a lessor. If you choose this route, you will work with a leasing company to figure out what you need and what you can afford. The lease and the equipment in this scenario, comes from the lessor. If you choose to get your lease and equipment from the lessor, you may want to shop for your equipment before tackling the lease. A leasing company is not necessarily the place to get your technical information.
Here are some of the issues you need to consider when you're looking at leasing:
- Ownership -- The most obvious downside to leasing is that when the lease runs out, you don't own the piece of equipment. Of course, this may also be an advantage, particularly for equipment like computers where your technology needs may change very quickly.
- Total expense -- Leasing is almost always more expensive than buying, assuming you don't need a loan to make the purchase. For example, a 3-year lease for a $5,000 computer system (at a typical rate of $40/month per $1,000) will cost you a total of $7,200.
- Finding funds -- Lease arrangements are usually more liberal than loans. While a bank might require 2-3 years of business records before granting a loan, many leasing companies evaluate your credit history on shorter terms (6 months is fairly typical). This can be a significant advantage for a start-up business.
- Cash flow -- This is the primary advantage to leasing. It eliminates a large, single expense that may drain your cash flow, freeing funds for other day-to-day needs.
- Taxes -- Leasing almost always allows you to expense your equipment costs, meaning that your lease payments can be deducted as business expenses. On the other hand, buying may allow you to deduct up to $19,000 worth of equipment in the year it is purchased (as part of first-year expensing); anything above that amount gets depreciated over several years. With the first-year expense deduction, the "real cost" of a $5,000 computer system may be only $3,400.
- Technology needs -- Technology advances at a rapid rate. If you buy a computer other high-tech equipment outright, you may find yourself with outdated equipment in 2-3 years, with no discernible resale value. Leasing may allow you to try out new equipment configurations, and update your system regularly to stay on top the technology curve. On the other hand, if you have a "pass-down" policy in your company (where older technology gets used by certain departments), buying may be more effective.
Here are some of the issues you should look for when negotiating your lease, or reviewing your lease contract:
- Length of the lease -- This is often called the "term" of the lease, and is usually between 12 and 36 months. The shorter the term of your lease, the higher your payments. 36 months is typical for a computer lease, although you might want to look at a 24-month lease to keep up with changing technology. The cost of 12 month leases is usually prohibitively high, and many experts only recommend you look at this option if you have a compelling reason.
- Total cost -- Analyze all the charges for which you will be accountable for the entire length of your lease. These include your initial down payment, monthly payments, a security deposit, any insurance charges, service/repair costs, etc.
- Cancellation clause -- This allows you to break your lease, although you will be liable for substantial penalties. This way, if you close your business, change its focus, or no longer need a piece of equipment, you won't be liable for the entire term of the lease.
- Assignment -- Find out if you can assign the lease to another party, and if so, what it costs.
- Modern equipment substitution -- If technology changes rapidly, you might want to consider this option. This allows you to update or exchange your equipment so you don't get stuck with something that's obsolete.
- Service plans -- Find out if your lease comes with an on-site service plan, and if so, determine its length. If you have only 1 year of on-site service, you may need to extend it to the length of the lease; otherwise, you will be responsible for all repairs yourself after the first 12 months. Also, be sure the contract spells out when the service will be performed (ideally, next business day).
Read the fine print of any lease you sign. There is such a thing as a lease that is considered a purchase -- which means you would not be able to deduct your monthly payments. A capital purchase has occurred if the terms of your lease agreement are constructed so that you meet one of the following criteria:
- You have a "bargain buyout" in which you can purchase the machine for a token amount at the end of the lease.
- You are leasing the machine for 75% of its useful life.
- The total payments made during the period of your lease equal more than 90% of the fair market value of the machine. Keep in mind that payments include finance charge and sales tax, and they need to be deducted to find the true price you're paying for the equipment.
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