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 $38.5 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.
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 small business operations. An equipment lease also ensures you aren’t worrying about equipment going obsolete or depreciating.
Benefits of leasing equipment
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.
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
Not having ownership of a piece of 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 business 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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Equipment leases versus other equipment financing options
When comparing equipment leasing to other financing options, it’s essential to understand the key differences and factors to consider.
In this section, we’ll discuss equipment leasing in comparison to other common business financing options, such as bank loans, lines of credit, and equipment loans.
Equipment leasing vs bank loans
Bank loans are a traditional method of financing that involves borrowing money from a financial institution for equipment purchases. Here are some key differences between equipment leasing and bank loans:
- Collateral: Bank loans typically require collateral, which can include other business assets or personal guarantees. Equipment leasing doesn’t usually require additional collateral, as the equipment itself serves as the collateral.
- Down payment: Bank loans may require a significant down payment, whereas equipment leasing often requires little to no down payment.
- Interest rates: Bank loans often have lower interest rates than equipment leasing, but this depends on the borrower’s credit history and market conditions.
- Ownership: With a bank loan, the business owns the equipment, while leasing involves renting the equipment from the lessor.
Equipment leasing vs. lines of credit
Lines of credit are revolving business loans that allow businesses to access a predetermined amount of funds as needed. Here’s how equipment leasing compares to lines of credit:
- Flexibility: Lines of credit offer more flexibility, as businesses can draw funds when needed and only pay interest on the amount used. Equipment leasing involves fixed payments for a specific term.
- Interest rates: Lines of credit may have variable interest rates, while equipment leasing generally has fixed payments over the lease term.
- Payment structure: Equipment leasing requires regular lease payments, whereas lines of credit involve interest-only payments on the outstanding balance.
- Equipment as collateral: With equipment leasing, the equipment itself is the collateral, while lines of credit may require other business assets as collateral.
Equipment leasing vs. equipment loans
Equipment loans are a specialized form of financing designed specifically for purchasing equipment. Here’s how equipment leasing stacks up against equipment loans:
- Ownership: Equipment loans enable businesses to own the equipment, while leasing involves renting it from the lessor.
- Interest rates: Equipment loans often have lower interest rates than equipment leasing, as the equipment serves as collateral, reducing the lender’s risk.
- Loan term: Equipment loans typically have fixed terms, whereas leasing offers both short-term and long-term options.
- Tax benefits: With equipment loans, businesses can claim depreciation and may be able to deduct interest payments. Equipment leasing payments may be tax-deductible as an operating expense.
Types of equipment leases
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 lease 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 working 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 at fair market value 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
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 new or used 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.
How to get started with equipment leasing and financing solutions
Follow these steps once you’ve decided whether leasing or financing is right for you:
1. Assess your equipment needs
Determine the specific equipment your business requires and estimate the total cost. Consider factors such as the equipment’s lifespan, maintenance costs, and potential obsolescence.
2. Evaluate your financial situation
Review your company’s financial statements, including cash flow, balance sheet, and income statement. Determine your available cash reserves, credit history, and debt levels. This information will help you decide whether leasing or financing is the more feasible option.
3. Research lenders and lessors
Identify potential lenders and lessors that specialize in your industry or offer the type of lease or financing you need. Research their reputation, terms, and conditions to ensure they’re a good fit for your business.
Some companies to check out include:
4. Prepare a detailed application
When applying for a lease or financing, you’ll need to provide documentation such as:
- Business financial statements
- Tax returns
- A detailed business plan
- A list of your existing equipment and assets
- Personal financial information for the business owner(s)
- Credit score reports
Ensure your application is thorough, accurate, and well-organized to increase your chances of approval.
5. Compare offers and negotiate terms
Review the offers you receive from lenders and lessors. Carefully compare interest rates, terms, fees, and other conditions. Don’t be afraid to negotiate terms to secure the best deal for your business and lower monthly payments.
6. Review the contract
Before signing any lease or financing agreement, thoroughly review the contract and consult with a legal or financial professional if necessary. Ensure you understand all terms, conditions, and obligations.
7. Close the deal and acquire your equipment
Once you’ve signed the lease or loan agreement, make any required down payments or initial payments, and acquire your equipment. Keep detailed records of all transactions and agreements for future reference.
By following these steps, you’ll be well on your way to acquiring the equipment your business needs through leasing or financing, positioning your company for growth and success.
Equipment leasing tips
Follow these tips to finance equipment in a way that’s profitable 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 options 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 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 purchasing 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.