Do you want to expand your business and you need to raise funds for it without going into long term debt or giving up equity? Then here’s an-in-depth guide to using equipment leasing as an alternative financing option. Equipment leasing is one of the easiest, yet commonly overlooked ways to finance your business.
Although it won’t really add to funds you already have, it will help you save a lot of money that can be converted to other relevant uses. In this chapter, you will learn the basics of equipment leasing and how to adopt it as a way of financing your business.
What is Equipment Leasing?
Equipment leasing is an arrangement in which a business rents the equipment needed for its operations for a specific number of months and at a specific cost. At the end of the lease period, the business (or lessee) may purchase the equipment for its fair market value (or a fixed or predetermined amount), continue leasing it, or return it to the owner (lessor).
Let’s use this scenario as an illustration: You want to purchase a bunch of Dell servers to run your web application. Dell can lease the servers to your company instead of selling them to you. The deal will require you to pay a fixed monthly cost for the period for which you intend using the servers. At the end of the lease period, your company will have the option to buy the servers (and own them permanently) or return them back to the lessor (Dell in this case).
The basic advantage of equipment leasing is that it costs much less than purchasing new equipment. This makes it a lifeline for cash-strapped businesses struggling to keep afloat. It’s also alluring to entrepreneurs who are trying to bootstrap.
If you are wondering why equipment leasing is regarded as a way of “financing” a business, then look at it this way: “Equipment leasing is a loan arrangement, in which you borrow equipment instead of money.”
Types of Equipment Leases
There are two types of equipment leasing arrangements. They are:
a. Operating leases
Also known as service leases, operating leases provide for both financing and maintenance. That is, the lessor is responsible for maintaining the equipment as the lessee uses it. The cost of this maintenance is usually worked into the rental fee paid by the lessee. Computers, office copiers, trucks, medical diagnostic equipment, and automobiles are typical examples of equipment involved in operating leases.
In addition, operating leases are not fully amortized, in that the payments required under the lease arrangement are usually not sufficient for the lessor to cover the full cost of the equipment. However, the lease period is usually much shorter than the expected useful life of the leased equipment, and this helps the lessor to eventually recover the full cost of the equipment through lease renewal or sale of the equipment.
A final feature of operating leases is that they allow for a cancellation clause, which gives the lessee the right to cancel the lease and return the equipment to the lessor before the lease expires. This clause is important to the lessee because it allows the equipment to be returned if it is rendered obsolete by technological advancement or is no longer needed because of a decline in the lessee’s business.
Payments on operating leases can be structured in two ways. They may be made periodically (usually monthly), in which case the cost to the lessee is known with some certainty. Payments may also be made per procedure, in which case a fixed amount is paid each time the equipment is used—for example, for each X-ray taken, in the case of an X-ray machine.
In a pay-per-procedure arrangement, the cost to the lessee and the return to the lessor are not known with some certainty, since it depends on volume. In essence, a per-procedure arrangement converts a fixed cost for the equipment into a variable cost that is based on volume.
b. Financial leases
Also called capital leases, financial leases are different from operating leases, in that they do not provide for maintenance, they are not cancellable, and they are generally carried for a period that corresponds with the approximate useful life of the equipment. Therefore, they are fully amortized.
In a typical financial leasing arrangement, the lessee chooses the item it requires and negotiates the price and delivery terms with the manufacturer. The lessee then arranges to have a leasing firm (lessor) buy the equipment from the manufacturer. After the lessor has acquired the equipment, the lessee then executes a lease agreement with the lessor.
The terms of a financial lease usually call for full amortization of the lessor’s investment plus a rate of return on the lease that is close to the percentage rate the lessee would have paid on a secured term loan. At the end of a financial lease, the ownership of the leased equipment is usually transferred from the lessor to the lessee.
Although there is a theoretical distinction between operating and financial leases, today in practice, leases often do not fit exactly into any of the two categories, as lessors now offer leases under a wide variety of terms that cut across both categories.
8 Advantages of Equipment Leasing for Small Business Owners
Aside that it helps to cut equipment purchase costs and gets you the tools you need without paying the full cost upfront, equipment leasing also has a number of other advantages:
- In a tough economic climate, equipment leasing can help you free up the cash sitting in fixed assets that are not utilizing their maximum earning power for your business.
- Equipment leasing lowers your depreciation and financing costs and improves your balance sheet because your overall debt to tangible net worth will improve.
- It’s usually easier to get an equipment lease than to get a loan for new equipment. And because equipment leases are not bank loans, your credit lines are freed up for other needs.
- Equipment leasing saves you from the compulsion of spending your funds on other than what you planned using them for (since equipment cannot be exchanged like cash).
- You get tax savings on equipment leases because lease payments are often deducted as business expenses.
- With equipment leasing, you get quick and easy upgrades. When you lease, you are able to exchange an obsolete piece of equipment for the latest model once the lease period is over. This is quite unlike buying the equipment, which leaves you stuck with outdated equipment for many years.
- Equipment leasing usually attracts much lower monthly payments than loans.
- By leasing equipment, you will avoid the risks and costs associated with equipment ownership.
Disadvantages of Equipment Leasing:
Equipment leasing also has a few downsides:
- You will pay a higher price for the item you purchased over the long term
- Since leasing commits you to retain the equipment for the lease period, this can be problematic if your business is in a flux.
8+ Questions to Ask Before Applying for an Equipment Lease
As you put together an equipment leasing package, you must consider the following:
- What equipment do you need and for how long? (If you will need the equipment over a long period of time, leasing such equipment will most likely be more expensive than buying it).
- What is the total payment cost? (Would the lease save much cost when compared with buying the equipment?)
- Have you anticipated your company’s future needs so you are sure leasing would be preferable to buying?
- Will you be leasing from a manufacturer or a leasing company? (Leasing from the manufacturer is usually cheaper and comes with maintenance by the lessor).
- For how long has the lessor you are approaching been in business? (As a rule, you should deal only with lessors that have been operating for at least as many years as the period of your proposed lease).
- Is casualty insurance (required to cover damage to the equipment) included?
- Who pays the personal property tax?
- Who or what will be responsible for the repairs and maintenance?
Every lease decision is unique, so it’s important that you study the agreement carefully before signing. You should also compare the costs of leasing to the current interest rates and examine the terms to see if they are favorable.
Finally, you must bear in mind that equipment leasing is more difficult for startups because your business has no credit history. But some lessors will consider your own credit history (rather than that of your business) during the approval process.
To apply for an equipment lease, you will need to visit the website or nearest office of the leasing company to find out more about the application process. This is because equipment leasing companies adopt different methods for receiving applications. However, most lessors now receive applications through their websites and via email.
List of Equipment Leasing Companies in the United States
- United Rentals, Greenwich, Connecticutt
- Sunbelt Rentals, Fort Mill, South Carolina
- Hertz Equipment Rental Corporation, Park Ridge, New Jersey
- Home Depot Rentals, Atlanta
- Aggreko North America, Houston
- Ahern Rentals, Las Vegas
- Neff Rental, Miami
- Sunstate Equioment Company, Phoenix
- NES Rentals, Chicago
- Finning, Edmonton, Alberta
List of Equipment Leasing Companies in Nigeria
- Abuja Equipment Leasing and Hire Company Limited, Abuja
- Richmond Equipment Services Limited, Lagos
- Algebra Support Services Limited, Port-harcourt
- G-seven International Resources Limited, Warri
- Buildwell Plants and Equipment Industry Limited, Lagos
- Boye Komolafe and Company, Lagos
- Quick Access Property, Lagos
- Focus Real Estate Service Limited, Lagos
- Essential Concierge Services, Lagos
- Binitie Properties Limited, Lagos
Continue to the Final Chapter: How to Write a Fundraising Proposal
Go Back to Chapter Thirteen: How to Raise Funds through Mergers and Acquisitions