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Equipment Leasing Is It for You?
In this “never enough time or money” world we live in, there is always a wish list of equipment that we “must have” and that we can't afford. There are common-sense formulas that I have found helpful to determine if you really need the gear. First of all, ask yourself if it can pay for itself by increased revenue or by winning a new client. Next, how you are going to pay for it? A very important consideration is exploring the option of equipment leasing as an alternative to direct purchase.
There are a great many arguments for and against leasing, as opposed to buying. We will try to review the sensible choices here, in general terms, to help you decide what is best for your financial situation, given the net worth of your business, how good your credit history is, your current positive cash flow, and the amount of additional monthly payments plus taxes and insurance you can afford (in your opinion and in the leasing company's opinion). We will also consider how much additional cash flow you can reasonably expect to generate with your lease/purchase and your own desire to lease vs. buy.
The basics of leasing vs. buying are fairly simple. If you buy something, you either write a check or borrow the money from someone, such as your bank or your mother-in-law, for which you negotiate terms of repayment. You may, in addition, negotiate “extended terms” (sometimes called “dating”) with the manufacturer/ dealer/owner of the desired equipment to pay them cash with no interest over a short period of time, usually between 30 days and 6 months. This is an additional way to preserve your capital, and also allows you to retain your cash or stretch out your borrowing over a longer period of time. When you buy, you take title to the equipment after you pay for it, enter it into your asset accounts, and hopefully start to make money immediately with the new (or used) gear.
If you have not leased equipment before and decide to take a look at this method of financing, here are some helpful hints. First, I always found that leasing major purchases such as consoles, digital video equipment, expensive video/audio tape machines, or video editing equipment makes good sense because it simplifies your cash planning, making it easier to determine how much you have to pay each month, along with the rent, telephone, and payroll, to stay in business, or open that new room.
Second, it preserves your credit line with your bank, which is usually based on up to 75 percent of the liquidation value of the assets you own. These new assets you are leasing will simply not be part of your owned asset base, because the leased equipment will be owned by the lessor until you purchase it from them—if you choose to do so at the end of the lease. This means that if you miss a payment with your bank loan, that institution can foreclose on your entire pledged asset collateral base, whereas if you miss a payment with your lease company (depending upon how the contract reads) the lessor will only be able to repossess the equipment covered under the lease. This is financial leverage, getting the “most bang for your buck,” in its simplest form.
Third, find out from your recording studio friends and industry associations who the good leasing brokers are, and how much over bank prime rate they are charging for their leases. The long-term relationship you develop with an equipment leasing company/broker is like the relationship you should have with your banker. After you develop a payment history with them, they will probably use all of their business ability to help you finance new equipment in the future.
A leasing broker is a company that will do all the paperwork on your lease and then usually place it with a bank. The lessor will then pay the seller of the equipment. The financial arrangement is now between you and the bank or other lender (the lessor). You will make your payments to them, and at the end of the lease term, you will have the option to purchase the equipment for a fixed residual value (usually 10 percent of the purchase price, but the minimum differs by local state tax rules), or return the equipment to the lessor, who will then sell it to someone else. This is known as a “capital” or “dollar option” lease and is the most popular type of equipment lease in our industry. There is also the “true value” or “market value” lease, which stipulates that if you decide to purchase the equipment at the end of the contract, you pay the equipment's fair market value at that time.
Also remember that you may have to pay additional state sales tax to the lessor if you purchase the equipment under either type of lease. This amount must be added to the residual vs. market value of the equipment to help you determine if you have any equity and should purchase the equipment at the completion of the contract. Sometimes there is a substantial difference between the residual value you have the option to pay at the end of the lease and the market value for which you can sell the equipment. This is another factor that can make leasing very profitable for you, the lessee.
Most of the time, the interest rate that you, the lessee, will pay and the quality of the financial institution where the broker is able to place the lease will depend upon your credit worthiness, and upon the equipment manufacturer's willingness to guarantee your payment of a large percentage of the lease (called a “buy back guarantee”). The average interest rate paid by the lessee is normally several percentage points (called “the spread”) over bank prime rate (check the financial section of almost any major newspaper), fixed for the duration of the lease at the time of signing the documents. Some leasing companies charge as much as 12 percent over prime, depending upon the type of equipment and your financial stability (or lack thereof) and the aforementioned manufacturer's payment guarantee. It is wise to get approval from your leasing broker for the dollar amount and the type of equipment you wish to purchase, in advance of signing the purchase order with the seller, since each broker has their own administrative requirements. With the leasing company's preapproval in hand, you can also usually negotiate a better price with the equipment seller, since he or she then knows that you already qualify for the necessary financing of the equipment.
Information that the broker/lessor is certain to ask for when you apply for an equipment lease will include your profitability and ability to pay, whether the monthly payment clearly will be generated by additional cash flow from the investment, your reputation in the industry, how long you have been in business, and your timely payment history of credit obligations and taxes. In addition, the broker will study your present and past financial and tax statements to confirm your company's ability to take on the additional financial obligation of the new lease. The information received will determine whether you have to personally guarantee the lease with your personal assets (such as the equity you have in your home) or whether the studio business entity is strong enough financially to provide the necessary collateral for the transaction.
The normal terms available in audio equipment leasing today are:
1. The average lease is written for 5 years, (particularly for consoles, of which an estimated 80 percent are leased), with 3 or 4 years as the second most popular preference.
2. In the majority of leases, the original warranty of the manufacturer is passed through from the lessor (the owner of the equipment) to you the lessee.
3. Most contracts are capitalized leases, which means that you, the lessee, can claim as a tax deduction the depreciation for the equipment as well as the monthly interest paid on the lease.
4. Late fees and lease termination for failure to make payments are determined in the lease documents. Approximately 10 percent of equipment leases result in foreclosure by the lessor, according to present industry statistics.
5. Your down payment can be anywhere from a simple first and last month's payment, to as much as 15 percent of the equipment's purchase value (with some lessors requesting as much as 25 percent down if your credit payment record is really questionable).
6. Your extra interest expense or other early lease termination costs are fixed should you decide to purchase the equipment prior to the completion of the agreed-upon lease duration.
The primary tax rule that allows these and sometimes additional deductions to be taken by you is your “intent to own” the equipment at the completion of the lease term. Check with your accountant for a more detailed explanation of your particular situation. It is very important to remember that all of these terms are negotiable between you and the lessor and must be stated in writing as part of your lease contract.
My own personal equipment-leasing history: I would always lease any major equipment in order to save my bank credit line (determined by my asset collateral base) for other major financial obligations that required total cash payment, such as construction. This also gave me greater financial leverage (my actual net worth vs. what I was able to finance). You should have a serious discussion with your tax accountant about all of the information presented here, because each personal or company financial situation substantially differs in terms of how much financial risk you are willing to or should take. Good luck!