Capital Raising Strategy: Use Lease Financing

Lease financing, a long-term form of renting equipment, has taken the business world by storm. The leasing business is booming, and for good reason: Leases offer a variety of advantages to companies that use them. Although most leases don’t generate capital (sale-leaseback is an exception), they do make it possible for businesses to acquire the equipment they need without a large cash outlay upfront ‘” enabling companies to leverage their cash into a variety of capital needs.

So who leases equipment instead of purchasing it? You may be surprised by the answer. According to industry statistics, 85 percent of U.S. businesses currently lease at least some of their equipment ‘” anything from locomotives to computers to desks and chairs. They spend $233 billion a year in the process, double the number of a decade ago. Chances are your company already leases at least some of its equipment, perhaps a copier or telephone system.

A lease is a contractual arrangement whereby an individual or company that owns specific business equipment or property (the lessor) allows another business (the lessee) to possess and use the equipment or property in exchange for cash payments or other agreed-upon compensation. Leases have a fixed term (duration), and lessees usually make payments on a monthly basis.

What’s the difference between leasing equipment and renting it? Actually, there is no legal difference between the words lease and rent. A lease is usually considered to be a relatively long-term arrangement (one year or more), however, whereas a rental agreement is a relatively short-term arrangement ‘” anywhere from an hour or two to a day, a week, or a month.

Leasing contracts tend to be fairly complicated agreements. But, while every leasing agreement is almost guaranteed to have page after page of legal requirements, a few key items are part of the majority of lease agreements. These key items ‘” all of which are subject to negotiation ‘” are the following:

  • Lease term: Lease agreements are in effect for a specific period, generally from a minimum of one year up to ten years or more for expensive, long-life equipment. The longer the term of the lease, the lower the monthly payment, with all other things being equal.
  • Residual value: Most leases specify the value of the equipment at the end of the lease term ‘” its residual value ‘” an amount that is estimated at the inception of the lease agreement.
  • Rental rate: The rental rate is the amount of money you’ll pay the lessor each month for the privilege of leasing your equipment. You determine the rental rate by multiplying the cost of the equipment by a rental rate factor representing the cost of money (similar to the interest rate in a loan).
  • Purchase option: This contractual condition spells out whether you have the right to purchase the equipment at the end of the lease term and, if you do, how much it will cost to do so.
  • Early termination: Terminating a lease before the termination date set forth in the leasing contract. Obviously, the lessor would prefer you to maintain your lease for the full duration of the leasing agreement and will push for substantial penalties for early termination.
  • Closed-end lease: In a closed-end lease, you owe nothing at the end of the lease term ‘” you can simply walk away, assuming that you have returned the equipment and that it has suffered no damage beyond normal wear and tear.
  • Open-end lease: In an open-end lease, you pay the difference between the fair market value of the equipment and the residual value established in your lease agreement (only if the fair market value is less than the residual value) if you decide to return the equipment to the lessor at the end of the lease term.