Lining up your equipment: it may pay you to lease, not buy
Steven Shulman's leasing experience started nine years ago, about the time of the start-up of his company, Jansson Inc., a wholesale stationery printer in Waltham, Mass. ``You can't really approach a bank for $5,000 or $10,000,'' he says. Banks want to loan you more than that. Mr. Shulman's firm would either have to defer purchasing needed equipment or borrow -- and buy -- more than was needed. Precious working capital would be tied up in the process.
Instead, when the company needs a new typesetter, ``the source of capital to finance the equipment is never at issue,'' Shulman says. He picks up the phone to call his leasing company, Eaton Financial Corporation, and he has the papers authorizing the purchase of the typesetter that afternoon.
Eaton's lease payments are higher than the corresponding loan payments would be. But Shulman finds that preserving his working capital -- while avoiding the ``labyrinth of the banking community'' -- is worth it. Because of his established relationship with Eaton, he has the equipment when he needs it and doesn't have to apply to dozens of different vendors for credit.
Like Shulman, more business people are starting to see leasing as not just another way, but as the best way, to acquire production equipment.
Small and large businesses lease everything from dairy cows to satellites, from airplanes to computers, says Katherine Tynberg, of the American Association of Equipment Lessors in Arlington, Va. The leasing industry is growing 15 percent a year, she adds.
Growth wasn't this rapid 10 years ago. But the recession left more than one company that lacked the profits to take advantage of increased tax write-offs from buying capital plant and equipment.
Leasing companies sprang up to fill the gap. And private investors followed, eager to help them. Typically, private investors lend money to leasing companies at a lower rate in exchange for tax benefits, says Ray Mullaney of Capital Planning & Services, a management and financial consultant. These lower costs are passed on to the lessee in lower leasing rates. At times, leasing rates are lower than the loan payments would be.
Rapid changes in technology have contributed to the growth of leasing, too. Leasing is a hedge against obsolescence, says Ms. Tynberg. Instead of buying equipment that will quickly become obsolete, companies lease it, eliminating the need to find a buyer for old equipment a few years down the road.
Businessmen like the fact that leasing equipment (instead of borrowing to buy it) leaves their regular credit lines open for emergencies. Leasing companies offer fixed-rate 100 percent financing, and often for longer terms than banks, says Tynberg.
Leasing companies are also more willing than banks to finance equipment in risky situations, and they are more aggressive in their marketing. They come to the small business asking to lease out equipment; the small-business man doesn't have to seek them out as he does a bank.
Leases can often be less visible than a debt on the company balance sheet. This improves key asset-to-debt financial ratios. Leasing also allows a company to acquire equipment unforeseen at capital equipment budgeting time: It's easier to expense a smaller monthly payment than to go back later to ask for a $100,000 capital machine.
Leasing terms also can be very flexible. For example, a farmer's lease for a piece of equipment can be drawn up to include no lease payments until after his crop comes in, Tynberg says.
Leasing costs are commonly written off as expenses each month, which reduces a company's taxable income. And under certain circumstances, the IRS allows companies to depreciate the cost of equipment they are leasing.
If a lease includes a bargain purchase option to be exercised at the end of the lease, the IRS assumes the company will buy the equipment for the bargain sum. The IRS allows it to depreciate the equipment as if it were owned by the lessee. Yet with all its conveniences, Mr. Mullaney notes that the cost of leasing money is sometimes higher than that of conventional borrowing. A business that has plenty of cash or credit available may well be advised to borrow money to buy its own plant or equipment.
In one instance that Mullaney researched, lease payments on a $10,000 piece of equipment would vary from $425 to $354 a month over three years. Bank financing, however, would cost $274 a month if the rate were 14 percent, with a $2,000 down payment.
If the $80-a-month saving from the buying decision ($354 minus $274) could be invested at 14 percent, the business would have accumulated $3,554 at the end of three years. If the decision were to lease, the $2,000 down payment at 14 percent would have grown to only $2,963.
In the case above, buying the equipment would have been the most efficient use of money. But each separate case requires some careful thought and figuring, considering the costs and benefits of both leasing and buying to find the best alternative to fit the specific case.
Ninth in a series. Next week: Advertising strategies.