What to Consider When Leasing Heavy Equipment

Leasing your equipment versus purchasing through a conventional bank loan makes better use of your money.

Most business owners have wrongly been conditioned to believe that through purchasing equipment out right they are saving interest and finance charges.

Banks charge lower interest rates than leasing companies, don’t they? Well, not exactly. That’s because rate per se, the cost per thousand dollars of equipment per month or the "interest rate" that is being factored into the transaction, is an unimportant consideration.

Far more important are the terms and conditions of the transaction.The terms of your "low rate" bank loan usually require that you keep some money, perhaps 20% to 30% of the loan amount in a non-interest bearing account at that bank as "compensating balances" (so the bank is really lending you 70 cents of their money and 30 cents of your own money for each loan dollar).

When you compute the real yield on that, you find that a five year 8% loan with a 30% compensating balance requirement is really about a 24% loan (because you’re paying interest on 100%, but only getting 70%). Using the same formula, a 20% compensating balance requirement makes their yield on that 8% loan almost 18% and with a mere 10% compensating balance, it's still about 12.5%.

So you have this “low” bank rate, but you have to leave part of the money in the bank. 

You also have covenants that require you to maintain certain financial ratios, the bank may have filed a blanket lien against your assets and you are cross collateralized with your personal accounts, your kids’ trust accounts and everything else. 

There is probably a clause in the loan agreement that says that if at any time the bank feels uncomfortable with your industry they can call the loan even if you have made every payment on time, and another that says they can increase their rate if their cost of money goes up.

Oh, and they probably didn't want to finance the entire cost, preferring that you made a down payment. In short, there are terms and conditions that you probably didn't know about and a rate effectively higher than you imagined.

So it is pretty clear that the “rate” is not the only factor in making a decision on how to finance equipment. You have to look a lot deeper.

Another factor militating against bank financing and conventional ownership is that new technology is obsolescing everything that was “new technology” before, and that is something that is going to continue to happen in the future... only faster.

So, given that most equipment is going to be worth very little very soon, conventional financing becomes even less desirable.

It is the use of equipment which generates profit, not the ownership.

While leasing companies may use the same name to describe a lease, the terms and conditions written in their contracts often vary. Be certain to review your documents carefully and ask your account executive to explain anything that is unclear.

Works best with equipment that rapidly depreciates or becomes obsolete in a short period of time. In a true or operating lease, the leasing company retains ownership of the equipment during the lease.

True or operating leases typically have no predetermined buyouts; customers usually classify these payments as an operating expense. This type offers the lowest payments and typically is the most tax-friendly form of leasing. 

True or operating leases offer three choices at the end of your lease:

• return the equipment to the leasing company,
• purchase the equipment at its fair market value or option amount, or
• extend your lease term

If you plan on owning the equipment at the end of the lease such as heavy construction equipment, ships or aircraft, the full purchase price plus interest charges are spread over the length of the lease. 

You will own the equipment at the end of the lease for a minimal amount, such as a fixed percentage of the original cost or $1.00.

Organizations that need a flexible repayment schedule such as seasonal businesses, agricultural companies, recreational services firms, and school systems. You specify months when no payments are made. You have the flexibility to adjust to irregular cash flow.

Local and state government organizations looking to acquire equipment, the tax structures and details of municipal leases vary considerably from standard business leases. 

Seek the advice of your financial advisor to better understand your municipal lease options. Municipal leases are designed specifically for local and state government organizations

For businesses that need equipment for operation and development that will not immediately generate revenue. A 60 or 90-day deferred lease can be structured as a finance lease or a true lease. 

There is usually no advance payment required, and the first payment is not due until 60 or 90 days after the lease begins. The equipment you need can be acquired with little to no money up front and no payments for 2-3 months

Businesses whose financed equipment will become more profitable over time, payments increase according to a regular schedule over the life of the lease. Payments can be differed to match cash flow.

If you and your accountant believe that leasing is more beneficial after having purchased the equipment, sale-leaseback allows your business to raise cash for other investments or cash flow purposes.

The business that has already purchased equipment sells it to a leasing company, which, in turn takes ownership of the equipment and then leases it back to the business. 

Most leasing companies require that the equipment be purchased within 90 days. The sale-leaseback allows you to put money back into your business or into investments that appreciate rather than depreciate.

In General you will need:

• A legitimate business
• A good personal credit score, FICA above 640
• Two years corporate tax returns and financial statements, preferably prepared by a CPA
• Two years of banking and trade references.
• Your business phone number listed in directory assistance.
• Your own company website and email..
• Dun & Bradstreet profile and Paydex score.
• In some cases, completed businesses plan (a good idea no matter what).

Under no circumstances apply to multiple leasing companies, vendors or retailers. The resulting damage to your credit from inquiries may prevent you from receiving any type of financing. Lease only the equipment you need. Do not let anyone talk you into leasing things you do not need. You can always add equipment to your lease later.

Contact Ren Ellis at Capital Asset Resources to learn more. rellis@capitalassetresources.com

(817) 416-8347