• Gene Vihodsef

Equipment Leasing: A Guide for Business Owners

Updated: May 24

Purchasing equipment is expensive, and it may be impossible for many small businesses to buy everything they need upfront. Equipment leasing is a way to spread out the costs over a set amount of time.

You may not own your equipment when you lease, but you don't have to worry about it becoming obsolete.

With equipment leasing, you pay a fixed rate for a specific period. The interest and fees are built in to the payment. Equipment leasing contracts typically run for three, seven or 10 years.

Buying and maintaining equipment is expensive, and as soon as you invest in a piece of machinery, it's only a matter of time before a new version comes out, making yours obsolete or inferior. Due to the high costs involved in owning and operating equipment, many small business owners opt to lease rather than own.

Leasing offers advantages that owning does not, including lower monthly payments, which are typically spread out over the course of months or years rather than delivered in a lump sum. Many commercial equipment leases also include service agreements or service add-ons, which offer peace of mind for business users and negate the need for in-house technicians.

If your business needs new equipment or technology, but you can't afford it, leasing may be an option to consider. Leasing lets you make smaller monthly payments, typically over a multiyear period instead of buying it all at once. At the end of the lease, you may return the equipment or buy it for a price that factors in appreciation and how much you paid over the life of the lease.

What is equipment leasing?

Equipment leasing is a type of financing in which the small business owner rents the equipment rather than purchasing it. Business owners can lease expensive equipment such as machinery, vehicles, computers and other tools needed to run a business. The equipment is leased for a specific period. Once the contract is up, the business owner must return the equipment, renew the lease or buy the equipment.

Equipment leasing is different from equipment financing – taking out a business loan to purchase the equipment and paying it off over a fixed term with the equipment as collateral. In that case, you own the equipment once you pay off the loan.

With an equipment lease, the equipment is not yours to keep once the leasing term is over. As with a business loan, you pay interest and fees when leasing equipment, and they're added into the (usually) monthly payment. There may be extra fees for insurance, maintenance, repairs and related costs.

Equipment leasing can be much more expensive in the long term than purchasing equipment outright, but for cash-strapped small business owners, it's a means to access necessary equipment without much upfront money.

Benefits of equipment leasing

  • Many lessors don't require a significant down payment.

  • If you need to continually update equipment, leasing is a good option, because you aren't stuck with obsolete equipment.

  • If you need to upgrade to more advanced equipment to handle a higher volume of work, you can do so without having to sell your existing machinery and shop for replacements.

  • Equipment leases are often eligible for tax credits. Depending on the lease, you may be able to deduct your payments as a business expense.

Of course, not all equipment leases are the same, and there are lots of ways to finance a lease. The lender we chose as the best overall also offers leasing options.

If you are unsure whether equipment leasing is a good option for you, continue reading to learn more about how to get started, the leasing process, the different types of leases available and what to consider when looking for a lender.

How to get started

Before you start the process, answer the following questions. It may seem like a lot of effort upfront, but without answering these questions as they relate to your business, you can’t make an informed decision on leasing or buying equipment.

What is your monthly budget?

Leasing offers substantially lower monthly payments than purchasing, but you still need to factor the costs into your monthly cash flow. Start with what you can afford and work from there; don't work the other way around by getting price quotes and trying to squeeze them into your budget.

How long will the equipment be used?

For short-term use, leasing is almost always the most cost-effective way for businesses to go. If you're using the equipment for three years or more, a loan or standard line of credit may be more beneficial than a lease. Factor in your business's growth as well: If your company is rapidly growing and evolving, a lease may be a better option than buying.

How quickly will the equipment become obsolete?

Technology becomes outdated more quickly in some industries than others. Consider obsolescence before deciding whether buying or leasing makes sense for you.

Purchasing vs. leasing

While many businesses benefit from equipment leasing, an outright purchase is more cost-effective in some instances. When comparing purchasing and leasing options, consider these factors:

  • Purchase price

  • The amount to be financed

  • Annual depreciation

  • Tax and inflation rates

  • Monthly lease costs

  • Equipment usage

  • Ownership and maintenance costs

Pros of leasing

A lease is ideal for equipment that routinely needs upgrading – for instance, computers and electronic devices. Leasing gives you the freedom to obtain the latest machinery with a low upfront cost, plus you have reliable monthly payments that you can budget for.

At the same time, leasing provides a wider range of equipment options for businesses. Leasing makes it financially possible to afford equipment that would otherwise be too costly to purchase.

Cons of leasing

Leasing requires that you pay interest, which adds to the overall cost of a machine over time. Sometimes, leasing can be more expensive than if you were to purchase the equipment outright – especially if you purchase the equipment when the lease term has expired.

In addition, some lenders enforce a specific term length as well as mandatory service packages. This can add to the cost if the lease term extends beyond how long you need the equipment. In this scenario, you could get stuck with a monthly payment as well as storage costs associated with unused equipment.

Pros of buying

When you own a piece of equipment, you can modify it to suit your exact needs. This isn't always the case with a lease. Similarly, buyers aren't bound by the limitations imposed by an equipment lessor.

Purchases also enable you to resolve any issues more promptly, because you don't have to obtain approval from the leasing company to schedule a repair or order a replacement part. In addition to the depreciation tax benefits, you can recoup some money by reselling the equipment when it's no longer of use to you.

Cons of buying

Like leasing, purchasing has its drawbacks. The biggest is obsolescence; with a purchase, you're stuck with outdated machinery until you buy new equipment. Also, the competitiveness of the marketplace and the availability of tax incentives with leasing are often enough to dissuade many business owners from purchasing equipment outright. The costs to maintain and repair machinery, in addition to a steep purchase price, may put too much of a financial strain on many businesses.

By some estimates, businesses budget 1% to 3% of sales for maintenance costs. This is a rough estimate, though. The equipment itself, service hours, equipment ages, quality and warranty determine the actual maintenance costs.

Equipment leasing vs. other financing options

A purchase isn't the only alternative to leasing. In fact, it's not even the most common. Loans, lines of credit and factoring services are popular means of financing large equipment as well.

Like a purchase, loans provide more ownership of the equipment. With a lease, the lessor holds the title to any equipment and offers you the option to buy it when the lease concludes. A loan enables you to retain the title to any of the items you purchase, securing the purchase against existing assets.

Unfortunately, terms can be the major drawback of a loan. Unlike a lease, which provides fixed-rate financing, a loan or line of credit's interest rates may fluctuate throughout the loan term. This can make budgeting problematic, depending on the size of the loan. In addition, banks and other lenders often require a much larger down payment – 20% of the total cost of equipment by some estimates.

Factoring is another way to purchase costly equipment and is often faster than applying for a loan. By leveraging your accounts receivable, you can quickly turn outstanding payments into cash by selling these invoices to a factor. Often paying up to 90% of the total value of your accounts receivable (depending on the creditworthiness of your customers), factoring is an ideal alternative to leasing and loans for startups and small businesses.

Funding is usually available in a matter of days. This makes factoring a popular resource for smaller manufacturing operations, the transportation industry, and businesses that routinely handle contracts with a fast turnaround.

The leasing process: What to expect

When applying for a lease, you can expect the process to include the following steps.

  • Step 1: You complete an equipment lease application. Be sure you have financial data available for your company and its principals, as this may be required upfront or after initially completing the application.

  • Step 2: The lessor processes your application and notifies you of the result. This usually happens within 24 to 48 hours of you submitting the application. Some lessors may not require financials and/or a business plan for applications on dollar amounts from $10,000 to $100,000. For financing on $100,000 to $500,000 (and up), expect to provide complete financials as well as a business plan.

  • Step 3: Once you receive approval, you must review and finalize the lease structure, including monthly payments and the fixed APR. You'll then sign the documents and resubmit them to the lessor, typically along with the first payment.

  • Step 4: When the lessor has received and accepted the signed documents and first payment, you are notified that the lease is in effect and that you are free to accept delivery of the equipment and commence any training necessary.

  • Step 5: Funds are released within 24 to 48 hours directly to you or the manufacturer you are purchasing from.

2 types of equipment leases: Operating lease and finance lease

Operating lease

There are two primary types of equipment leases. The first is known as an operating lease. In short, this structure allows a company to use an asset for a specific period of time without ownership. The lease period is usually shorter than the economic life of the equipment. At the end of the lease, the lessor can recoup additional costs through resale.

Unlike an outright purchase or equipment secured through a standard loan, equipment under an operating lease cannot be listed as capital. It's accounted for as a rental expense. This provides two specific financial advantages:

  1. Equipment is not recorded as an asset or liability.

  2. Equipment still qualifies for tax incentives.

Dealers' rates may vary widely, but in general, the average APR for an operating lease is 5% or lower. Average contracts last 12 to 36 months.

With the prevalence of leasing, new accounting regulations from the Financial Accounting Standards Board require companies to reveal their lease obligations to avoid the false impression of financial strength. In fact, all but the shortest-term equipment leases must now be included on balance sheets. While leased equipment does not have to be reported as an asset under an operating lease, it's far from free of accountability.

Finance lease or capital lease

Sometimes known as a finance lease or capital lease, this lease structure is similar to an operating lease in that the lessor owns the equipment purchased. It differs in that the lease itself is reported as an asset, increasing your company's holdings as well as its liability.

Commonly used by large companies, such as major retailers and airlines, this setup provides a unique advantage, as it allows the company to claim both the depreciation tax credit on the equipment and the interest expense associated with the lease itself. In addition, the company may choose to purchase the equipment at the end of a finance lease.

Given the financial edge this provides, the APR for a finance lease is higher, often double that of an operating lease. Standard interest rates currently hover between 6% and 9%. Average contracts range from 24 to 72 months.

Lessee responsibilities

There are additional responsibilities that can result in expenses above and beyond the cost of your monthly lease payment. These typically include the following items:

  • Insurance: Average estimates for liability insurance range from $200 to $2,200 annually, with many businesses reporting costs of $1,000 or less.

  • Extraneous costs: Depending on your lease structure, you may be held liable for some maintenance and repairs. Extraneous costs can also include any legal fees, fines and certification expenses.

  • Return of equipment: This includes transportation and shipping costs.

  • Fees: Read your contract carefully. Fees can be assessed for everything from a one-time documentation fee, which is sometimes as much as $250, to late-payment fees, which run from as little as $25 to as much as 15% of the amount overdue.

Comparing equipment finance providers

Given the costs and considerations addressed in the sections above, it's essential to compare several lease providers to ensure you get the best rate. Before beginning your search, you should familiarize yourself with the three different types of equipment finance providers and the benefits each provides.

Lease broker

A lease broker serves as an intermediary between you and any prospective lessors. The broker will present you with the offers and submit your requests for financing, handling much of the paperwork for you. Brokers represent only a small segment of the leasing market, and their service does not come cheap. Brokers reportedly charge 2% to 4% of the cost of the equipment to negotiate a deal. The benefit of using brokers is realized in their extensive relationships. Often industry-specific, they specialize in obtaining a wider range of equipment, sometimes at a better price than would be available through standard channels.

Leasing company

This is often the subsidiary leasing arm of a manufacturer or dealer. Also known as a captive lessor, a leasing company's sole aim is to facilitate leases with its parent company or dealer network. For this reason, you will usually only deal with a leasing company when working directly with a manufacturer.

Independent lessor

This type encompasses all third-party lease providers. Independent lessors include banks, lease specialists and diversified financial companies that provide equipment leases directly to a business. They differ from leasing companies in that they typically specialize in the remarketing of equipment, a skill that enables them to group products from multiple manufacturers and offer more competitive APRs.

Tips on choosing a lessor

The best advice for choosing a quality lessor is to examine them with the same level of scrutiny with which you and your business are being scrutinized. Give preference to those willing to partner with your business. This may be represented in the level of background and experience they have in relation to your line of business, or their willingness to work with you on certain terms. Some fees specified under the lessee responsibilities – particularly application fees and late fees (at least on the first late payment) – may be covered or waived altogether depending on the lessor.

Also take time to research the following:

  • Business information: Look into the payment history, credit history, business summary, corporate relationships, financial statements and any public filings.

  • Pending litigation: Search public records for any notices of pending litigation.

  • Payment system: Is it easy, or does it require mountains of paperwork?

Questions to ask a dealer

Before you choose a dealer, get price quotes from at least three companies, and ask all the dealers on your list these questions. Asking the right questions is half the battle for getting a fair deal on business services and goods.

How much money is required upfront?

Lease financing often provides 100% of the dues required for an equipment purchase. Loans do not, often requiring up to 20% of the total as a down payment. If a down payment is required, consider reassigning capital to cover any upfront costs.

Who takes advantage of the tax incentive?

Under a loan structure, your company can claim depreciation. However, you will have to provide a down payment, and the interest rate is higher. Under a lease, the lessor claims depreciation. In exchange, they offer a lower APR – often half that of a loan. If the depreciation credit is important to you and you still want to lease, ask about the availability of finance or capital leases.

Are the financing terms flexible?

Leasing is often viewed as the most flexible financing option, especially compared to loans. Depending on the structure of the lease, you can start with low payments and increase them as time goes by (known as a "step-up lease"), defer payment to give yourself an extra window before the first payment is due, and even add more equipment onto an existing lease under a "master lease" structure.

Disclaimer: this article by Mona Bushnell on equipment financing appeared in Business News Daily, and may be more applicable to a US-based business rather than Canadian.

Thank you,

Gene Vihodsef

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