The Equipment Lease
Smart Business Equipment Financing

The equipment lease was in its infancy 25 years ago. Today, businesses lease hundreds of billions of dollars worth of equipment each and every year.

Despite its popularity and widely acknowledged benefits, the equipment lease remains a misunderstood business equipment financing technique. Every entrepreneur and business owner should understand and consider leasing as an excellent way for a company to finance equipment.

Because the useful life of the equipment is matched up with the lease term, there is typically no down payment required. This 100 percent equipment finance option also can include service additions like installation, maintenance, and other services needed for your equipment to function properly.

Just about any type of commercial equipment can be leased. When you lease equipment, you achieve greater purchasing power and flexibility, since your business can obtain the best equipment available. The payments are more affordable, and this form of business capital is often easier to come by than other types of business financing, particularly when starting a new business.

Very Smart Business Financing

Leasing offers tremendous leverage without taking big risks!

With a one-page application and a couple of months of lease payments, your company can take control of equipment worth tens of thousands -- even hundreds of thousands -- of dollars, or more!

For the small business start-up, the equipment lease preserves precious capital needed to establish the company and sustain it in the beginning stages.

And for existing companies that have been able to build business credit, leasing leaves that credit available for other business needs.

Capital preservation, crucial for any new or growing business, is just one of the main benefits of the equipment lease. Being able to use the equipment as much as you need without encountering the risks of ownership is an added benefit to leasing. Your business won't have to deal with depreciation of the item nor will your business have to worry about the item becoming obsolete.

In addition, when you finance equipment using an equipment lease, your business may receive tax benefits. Typically, 100 percent of your lease payments are deductible as a business expense. So, depending on you firm’s tax situation and the equipment you are acquiring, leasing might be to your advantage when compared with equipment loans where only the interest can be deductible. In many cases, leased equipment will be cheaper after taxes than simply buying it outright with a traditional equipment loans.

Equipment Lease Terminology & Types

In your search for business equipment financing, you may hear some unusual words and terminology:

Parties to an equipment lease

  • Lessee: Your firm (the company acquiring the equipment)
  • Lessor: A commercial equipment finance company that provides the capital to acquire the equipment from one or more vendors on the lessee’s behalf.
  • Lender: The company selling the equipment (sometimes referred to as the “dealer,” particularly when titled equipment is involved).
  • Lease Broker: A company or individual that facilitates an equipment lease transaction by matching the lessee to the lessor.

Equipment Lease Types

There are essentially four different types of equipment leases:

  • Operating Lease
  • Terminal Rental Adjustment Clause Lease (TRAC)
  • Tax Lease/True Lease
  • Capital Lease

Your understanding of these lease options will help you select the best leasing solution for your business and for any type of commercial equipment you need.

Operating Lease

The operating lease, which closely resembles a typical automobile lease, is usually a good choice for short-term equipment needs. It allows you to lease needed equipment for a period that is shorter than its expected life. Because you will return the equipment while it still has functional value, the lessor may provide any maintenance and insurance during your lease term.

Smart Business Financing Tip

An operating lease does not qualify as a Capital Lease (see below), so it is not capitalized. As a result, you account for it as a rental expense.

Terminal Rental Adjustment Clause (TRAC) Lease

A TRAC lease provides the advantages of leasing while also giving the lessee an option to purchase the equipment at the end of the lease term at a price determined at the beginning of the lease – the vendor’s forecasted residual value.

Flexible payment options make the TRAC lease an attractive way to finance equipment, especially when starting a business. You are in control of your monthly payments, which are tied to the forecasted residual value at the end of the lease term. You can choose either a low monthly payment in exchange for a higher end-of-term price, or higher monthly payments and lower purchase price.

When a TRAC lease ends, you can:
  • Continue to lease with a new lease based on the equipment’s residual value.
  • Buy the equipment for the pre-determined price.
  • Return the equipment.
  • Replace or trade the equipment.
Tax Lease/True Lease

A low cost equipment lease option, the tax or true lease is ideal for equipment that you expect to become obsolete quickly. Computer equipment is a good candidate for this type of lease, since rapid advances in hardware and software can mean short life cycles in your business.

When you lease equipment using a true/tax lease, you have use of it for the term of the lease but no legal ownership

At the end of a tax lease/true lease, you will have the option to:
  • Purchase the equipment at the fair market value
  • Extend your lease
  • Return the equipment
Capital Lease

Capital leases and equipment loans are close cousins, but instead of borrowing money, a company can use a capital equipment finance equipment with a small initial investment and without depleting its available credit. It is treated as a purchase for accounting purposes and even though legal ownership of the equipment is not transferred to you until the end of the lease period, you can treat the equipment as an asset, claim depreciation, and deduct the interest expense. In other words, when you finance equipment with a capital lease, your accounting of it is the same as if you had borrowed money to purchase it.

Capital leases are best suited for equipment you will want to own and retain at the end of the lease.

To qualify as a capital equipment lease for tax purposes, at least one of the following must be true:
  • Legal ownership is transferred to you at the end of the lease term,
  • You have an option to purchase the equipment at a discount at the end of the lease term,
  • The lease term is at least 75% of the estimated life of equipment, or
  • The discounted lease payments are equal to at least 90% of the fair market value of the equipment.

Working Capital Financing: Sale and Lease-back Programs

If your firm owns equipment outright, you may be able to access your equity in it through a method of equipment refinancing known as a sale and lease-back.

In a sale and lease-back, you sell equipment to an equipment lease company for cash and agree to lease it (as a lessee) on a long-term basis using one of the lease types described above. Although you have use and possession of the equipment, you may give up your depreciation and tax benefits.

Choosing an Equipment Lease Company for Your Business

Once you have made the decision to lease equipment, you have to choose an equipment lease company.  Leasing comes in all shapes and sizes and can vary widely in both the types of equipment and size of the transactions they work with.  A micro-ticket company, for example, leases between $1,000-$25,000, whereas a large ticket lease company usually deals with leases of $5 million or more. There are computer leasing companies, companies that specialize in industrial equipment, construction machinery, business vehicle financing, and so on. If you don’t have the time or desire to search for your own equipment lease financing, you can let a lease or commercial finance broker do it all for you.

Try to find a company who is a direct lender and maintains their leases in their own portfolio. You will have a lot more flexibility, particularly if you need to restructure your lease during its term.

Also be on the watch for leases with prepayment penalties!

The equipment lease can be an important ingredient in any company’s business financing strategy.  Although it isn’t always the solution when financing a business, leasing is certainly an easy and flexible way to finance equipment without depleting cash reserves or taking out loans.

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