Equipment leasing is just one way businesses can keep operating costs low. Depending on the industry, the equipment can be one of the biggest expenses of running a business.
The good news is you can lease equipment for virtually all kinds of needs. As a $35.2 billion industry that’s seen growth year over year, the equipment leasing industry is an alternative way US businesses are meeting their equipment needs and managing overhead.
This guide is for businesses considering leasing equipment. Below, we walk through everything you need to know about equipment leasing, all the pros and cons that come with it, and how to decide whether it’s right for your business.
Table of Contents
What is equipment leasing?
Equipment leasing is when businesses rent equipment such as vehicles, tools, or machinery from third-party renters who own the equipment for rental purposes.
Equipment leasing is an effective way to keep business expenses low, and it can ease the process of storing and replacing equipment. Instead of buying their equipment, businesses can take advantage of equipment leasing services to only rent the equipment necessary as different needs arise.
How does an equipment lease work?
An equipment lease lets you pay a fixed rate over a predetermined period in exchange for the use of that equipment. A lease is an effective way to spread the payments of equipment out as a more financially accessible option than purchasing equipment.
Once you enter into a lease agreement with a leasing company or bank, you’re able to secure equipment—anything from heavy industrial machinery to construction equipment and more—to execute business operations. An equipment lease also ensures you aren’t worrying about equipment going obsolete or depreciating.
Benefits of leasing equipment
- Minimize upfront costs
- Improved financial flexibility
- Avoid equipment becoming obsolete
Minimize upfront costs
Especially if you’re a startup, minimizing upfront costs is one of the most effective ways to ensure you stay in business. If the industry you operate in relies heavily on equipment, the pros of leasing equipment can outweigh the cons.
Take control of your cash flow
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Improved financial flexibility
A healthy stream of cash flow is critical for any business that wants to operate profitably. That involves keeping expenses low and profit margins high. With the use of equipment leasing, your financial flexibility increases.
Instead of having to account for equipment purchasing expenses as well as depreciation and equipment updates, you can simply lease different types of equipment as the need arises.
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Avoid equipment becoming obsolete
Owning equipment is great until it becomes obsolete by advances in innovation. At that point, your equipment quickly becomes a liability instead of an asset. Opting to lease equipment instead of owning it ensures you don’t have to deal with outdated machines. It’s yet another way to stay competitive in your industry.
Drawbacks of leasing equipment
- You don’t own equipment
- You pay interest
- Can be costly for new businesses
You don’t own equipment
Not having ownership of your business equipment comes with its drawbacks. You’re limited on what you can do with it and how long you can use it.
You also can’t use the equipment for tax purposes, like writing off depreciation or being eligible for tax credits. From a financial standpoint, a history of leasing equipment instead of owning it may be interpreted less favorably by stakeholders like banks and third-party lenders.
You pay interest
Leasing equipment includes paying for the interest included in the lease. Rather than it being a flat fee for the duration of your lease, most companies charge an interest rate. Interest rates can vary, but are generally anywhere between 5% to as much as 20%.
Can be costly for new businesses
Are you a new business with no established credit? Leasing equipment might end up being a more difficult process. Lessors want to see that you have an established credit history that’s healthy. Without it, it might take paying more upfront to access leased equipment.
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Types of equipment leases
- Financial leases
- Operating equipment leases
- Lease to own
Each of these types of leases has pros and cons.
A financial lease, often referred to as a capital lease, is when the lessors own the equipment and the lease is reported as an asset. By the end of the lease, the company can purchase the equipment leased.
A financial lease is often used by large businesses, as it gives them a tax advantage. An equipment lease’s interest can be listed as an expense and allows for a depreciating tax credit. However, it’s not as easy as simply agreeing on a lease rate. Extra charges add to the overall cost of leasing equipment.
These can include:
- Additional fees (always remember to read the fine print in a contract)
- Equipment shipping expenses
- Liability insurance
- Additional equipment maintenance fees
Operating equipment leases
An operating equipment lease is designed to let companies rent equipment for a designated period without actually owning it. Equipment under an operating lease doesn’t have to be listed as a business asset but equipment can still qualify as a tax incentive.
The lessor creates a lease with a set APR and leases are usually created for longer periods. It isn’t uncommon to lease equipment for a year or more.
GAAP (generally accepted accounting principles) apply to operating leases. For example, a certain amount of equipment usage time needs to be recorded in a company’s balance sheet.
Lease to own
A lease to own, sometimes known as a PUT (purchase upon termination) lease is an alternative way businesses can purchase equipment if they don’t currently have the capital or credit history to do so. A lease-to-own setup allows companies to make ongoing payments within a specific period before claiming ownership of the equipment.
The general setup of a lease-to-own agreement plays out as follows:
- An equipment agreement lease with the option to purchase is created.
- A percentage of each payment made within the lease is applied to the purchase price of the equipment by the lessor.
- The lessor pays the balance left on the equipment once the lease is up.
- If the company decides to not purchase the equipment once the lease expires, the lessor claims ownership of the equipment and the payments accrued on it.
If by the time the lease is up a business isn’t ready to purchase the equipment, they have the option of filing an extension or agreeing to enter another lease. A lease-to-own agreement may be a viable alternative for up-and-coming businesses that require heavy machinery but don’t have the means to enter a traditional loan.
Providers of equipment leasing
- Equipment dealers
- Leasing companies
The most common equipment leasing entities include banks, equipment dealers, leasing companies, and brokers. Here’s what you should know about each one.
Much like banks provide car or mortgage loans, some also provide equipment loans on almost anything from computers to office equipment, and even manufacturing equipment. Once you enter into a lease agreement, you pay the bank a scheduled payment throughout your lease while it holds the title of your equipment.
With traditional equipment dealers, you pay interest plus fees on any equipment leased. Equipment dealers are solely dedicated to the business of buying and lending both used and new equipment to different companies.
Leasing companies offer equipment leases to businesses at a fixed rate over a specified period.
Brokers represent your company through the leasing process and talk to lenders on your behalf and are paid through commission. Using a broker during the leasing process may be a way to find better leasing agreements quicker.
Equipment leasing tips
- Scrutinize lessors closely
- Identify upfront costs
- Discuss flexibility of financing terms
- Consider tax implications
Follow these tips to find the right equipment lease for you and your business.
Scrutinize lessors closely
Before entering into a lease with a lessor, consider examining payment history, payment system, and any potential pending litigation, as these can be strong indicators of the success of a lease agreement. Part of doing the upfront work of scrutinizing lessors closely also ensures you’re able to establish a long-term relationship where you can communicate clearly.
Identify upfront costs
Hidden costs are everywhere and it’s no different for equipment leasing agreements. The list of less obvious leasing agreement costs can range from:
- Origination fees: This is a fee charged for the initial application process of an equipment lease that acts as payment for establishing the deal.
- Document processing fees: This fee is charged for all the paperwork involved in establishing a legal lease.
- Commitment fees: A fee awarded to the lender for its willingness to enter into a leasing agreement.
- Lease deposits: Often required if a company’s credit history isn’t in good standing. The deposit is deducted from the principal.
- Early payoff penalties: A prepayment or “yield maintenance clause” is often included in leasing terms. The lessee will either agree to incur early payoff penalties that can be a percentage of the total lease amount or the remaining balance left on the lease.
- Arrears billing and late fees: Much like other rental agreements, late payment fees can apply.
Before diving into a hefty lease agreement, taking the time to read through contracts is crucial in understanding what fees are applied to the process from beginning to end. This way, you aren’t surprised at an early payoff penalty that you weren’t aware of in the middle of your lease.
Discuss flexibility of financing terms
Whether you’re leasing from a bank, a broker, or a traditional leasing company, it’s important to thoroughly discuss any flexibility that can be offered during the financing process.
For instance, if you’re considering a lease-to-own setup, are you able to file for an extension at the end of the lease in the case your business isn’t in the financial standing to purchase the equipment? Are you able to renew the lease?
Discuss how flexible a leasing situation can be to ensure you’re planning for best- and worst-case scenarios. Since equipment can be one of the most expensive parts of running a business, the financial liabilities that come with leasing can be high. However, discussing the flexibility of your financing terms can help mitigate that risk.
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Consider tax implications
It can be argued that there’s more value in buying access to use equipment rather than also owning it. Besides the cash flow benefits, many tax implications make leasing an attractive option for all kinds of companies.
When deciding whether to lease or buy equipment, consider tax implications such as:
- A financial lease lets you keep the depreciation benefits
- Operating leases can help you avoid certain taxable scenarios
- If you meet specific qualifications, you can write off the entire lease payment as a business expense
As you make a decision on whether to lease or outright buy your equipment, considering the short- and long-term tax implications that come with it is one of the most critical parts of the vetting process. It’ll ultimately help you decide whether it’s the best financial scenario for your business and its stage of growth.
Is equipment leasing right for your business?
There’s plenty of upside for businesses that choose to lease their equipment instead of purchase it. However, some drawbacks can also apply.
Whether equipment leasing is right for your business depends on a handful of factors, including the industry you operate in, what your long-term financial plans look like, and whether it’ll cost less to purchase equipment, lease it, or opt for a combination of the two. A quick Google search can help you scope out leasing companies in your area.
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