Equipment Leasing 101 by benbenzhou


									Equipment Leasing 101
...Everything you need to know to make an informed leasing decision.

                       Strategic Business Funding
                       206 N. Randolph St., Suite 2
                          Champaign, IL 61820
                         Phone: (800) 621-6587
                           Fax: (800) 646-0984

                      Table of Contents

Introduction		                             2	

Equipment	Leasing	Overview	 	              3	

Benefits of Leasing                        7	

Types of Leases                            7	

Buyout	&	Purchase	Options	   	             9

Lease	vs.	Buy	    	                       10

Ownership	vs.	Use		                       10

What’s	Next?		    	                       11
           Welcome to
      Equipment Leasing 101
If you have or are considering purchasing new capital equipment or software
for your business, then you are aware that leasing is one way to acquire the
equipment for use in your business. But is it right for you? That’s why we wrote
this “Leasing 101” report; to give you a broad-based understanding of equipment
leasing so you can make an informed decision on how your business should
utilize leasing.

We are making this report available to you because it is our belief that the most
informed client is the happiest client. Equipment leasing isn’t rocket science, and
we wanted a quick and easy way to present information on leasing to our clients.
You should also know that equipment leasing is not always the best method to
acquire equipment for your business. When it’s not a good fit, we tell you. With
that said, it is our favorite because it is by far the easiest and fastest way business
owners can put new equipment to work in their business. Enjoy this report, and
please feel free to call our office if you have additional questions. We will be
more	than	happy	to	assist	you!


Equipment   The term ‘lease’ is probably now as commonly used as the term ‘cash’ when
            discussing potential financial arrangements. From apartments to office buildings,
 Leasing    land to vehicles, and equipment to software, literally hundreds of thousands of
            different products on the market can be lease financed. To some, that simply
 Overview   means signing a document and making payments. For others, it can be a more in-
            depth process requiring due diligence to ensure all steps are taken properly.

            In basic language, a lease is a contractual agreement in which a leasing company
            assigns the right of use of its equipment to the customer for a specific length
            of time and specific payment amount usually on a monthly basis. The leasing
            company is considered the lessor and the customer is considered the lessee. At
            the end of the lease term, the customer may have the option to either purchase,
            return, or continue to lease the equipment, depending upon the structure of the

            Businesses throughout the world have relied on leasing for years to provide
            a cost-effective way to acquire the equipment needed to focus on their core
            business activities to drive revenue. In fact, more than 80% of American
            businesses lease at least one of their equipment acquisitions. Nearly anything that
            is associated with the operation of the business can be leased and that includes
            software, hardware, capital equipment, office furniture, and even installation and
            consultation costs.

            Most companies choose the lease option due to the financial and operational
            benefits that it provides the business. Leasing can offer better value, more
            convenience, flexibility, greater control and even the option of financing 100%
            of the cost associated with new equipment. Organizations can also experience
            significant tax benefits from leasing. Although each company is different and
            should consult with a tax professional to know exactly what benefits they can
            receive, true leases can be 100% tax deductible and accelerate company write-
            offs to improve the overall financial picture.

            In most situations, leasing is easy. The company seeking lease financing will
            be required to provide their legal business name and other financial history
            information. The leasing company will usually take the process from there,
            leaving the simple tasks of signing the documents and taking delivery of the
            equipment to the customer. In some cases, equipment acquisitions totaling as
            much as $100,000 can get started with a simple one-page application.

Benefits of   Cost Structure - No Down Payment
              Lease financing offers many benefits for the customer or lessee, including the
 Leasing      variety of cost structures that are available. One of the most important benefits to
              note regarding lease financing is that such an arrangement does not require any
              upfront capital to secure the financing. Unlike traditional bank loans that require
              a substantial down payment that can be as much as 20 percent of the equipment
              cost, most lease agreements require no down payment. It is also perhaps the only
              financing structure that allows for 100 percent of the total cost to be included
              in the lease. Such provisions enables the organization to preserve its cash flow
              budget, while also enabling the organization to be in a better economic position
              to purchase what they need and not just what they can afford.

              Preserve Existing Credit Lines
              The amount of credit that is available to a company is of major concern,
              especially if the company is poised for growth. The company’s line of credit
              at the bank is preserved when leasing is selected as the payments are handled
              through another funding source. This available credit should be preserved
              for working capital, operations and expansion. Borrowing money through a
              traditional line of credit makes sense to meet short-term needs, but not for the
              long-term. Owning equipment is not what helps the company to make money;
              using the equipment does. Even if the company is cash rich, there are other
              things that the cash could be used for to enable the company to capitalize on the
              benefits of leasing.

              Hedge Against Inflation
              Inflation is also a big area of concern for those companies or individuals looking
              to lease purchase anything for their business. Many business owners, or those
              charged with acquiring equipment and other necessities for the business, are
              concerned with how inflation impacts the lease purchase and they often don’t
              understand whether the impact is good or bad. Anytime equipment is purchased,
              the depreciation must be taken in order to recover some of the cost. However,
              this depreciation is taken with tomorrow’s dollars that are less valuable than they
              are today. Because lease payments are fixed for the term of the lease, the business
              is able to continually decrease the real cost of the financing because payments are
              made with the eroded dollars of tomorrow.

              Aside from a basic cash purchase, there is no other financing option available
              to a business that offers the level of flexibility that can be available with lease
              financing. For those that are making the purchase decisions in the business, there
              are often capital budget restraints that limit or even prohibit the replacement of
              aging equipment at certain points in time. Even if the company relies heavily on
              the use of that equipment to drive revenues, the annual budget and current cash
              flow may not allow for replacement. When lease financing is used, however, the
              lease contract can be structured to accommodate the available funds to ensure
              that the company can acquire what is needed instead of only what the capital

              budget will allow.
Benefits of   The flexibility of a lease is especially important for the smaller business that has
              plans for expansion and growth in the near future. The equipment that may suit
 Leasing      their needs at the time of acquisition may not be adequate to accommodate the
              anticipated growth and that equipment may need to be upgraded and/or replaced
              before the lease term is expired. There are several options that businesses can take
              advantage of, including add-ons to the original lease or a master lease. An add-on
              allows for additional equipment to be added based on the terms and conditions of
              the original lease. A master leases allows for equipment or other purchase items
              to be financed under the umbrella of the master lease and governed by its terms
              and conditions but may vary in length or end-of-term options from the master
              agreement	or	other	equipment	on	the	agreement.

              Another area that leasing offers the greatest flexibility is for those businesses
              that operate in an industry that is seasonal. Consider that a landscaping business
              typically operates on a seasonal schedule, which means cash flow is seasonal
              as well. These businesses need things like software, computers, copiers, work
              trucks, skid steers, and more in order to function, yet these things are really only
              used to capacity during the months of the year that the business is most active.
              When the landscaper opts to lease finance these purchases, they can request that
              the lease be structured so that payments are only made during the months that
              they are actually open and generating revenue, gaining a reprieve from payments
              during the winter months. The same can be true for the construction company,
              the tax preparer and even the swimming pool installer that all gain the majority of
              their business and their revenue during certain times of the year. Lease financing
              offers the flexibility to be able to work within those restraints, providing great
              benefit to the business owner.

              Tax Benefits
              When considering whether or not to make a purchase, a business almost always
              considers the tax implications for doing so. Lease financing can actually offer
              considerable tax benefits to the organization that is considering entering into such
              an agreement. While every company should first consult their tax accountant
              or tax attorney before anticipating certain tax benefits from a lease transaction,
              there are certain benefits that are available to the customer that lease purchases
              equipment. In the instance of purchasing computer equipment, it is depreciated
              and written off over a five-year period. This five-year period actually spans six
              taxable years. In the world of technology, the true useful life of that computer
              equipment is much less than those six years.

              When the computer equipment is leased instead, those lease payments are tax
              deductible. If the lease covers a three-year period, the tax benefits produced
              over those three years will be considerably more than the ownership would
              have provided. In a typical 36-month operating lease, a company can deduct
              100 percent of the asset cost. In a forty percent federal and state tax bracket, 40
              percent of the total cost could come from simple tax savings. This is especially
              important in situations such as computer equipment where the assets lose their
              market value faster than their book value for tax purposes. The basic benefit for

Benefits of   the business is that when doing any type of leasing, qualifying lease payments are
              considered operating expenses and written off as made. This eliminates the need

 Leasing      for depreciation schedules and frees up more cash for other investments.

              A more specific reference to tax benefits is evident when looking at the Jobs
              and Growth Tax Relief Act of 2003, which increased the section 179 expensing
              limit to $100,000 for property placed in service during that taxable year. The Act
              also modified the phase-out limit at $400,000. This means that purchases over
              that amount will actually reduce your benefit dollar for dollar. Over time these
              limits have been adjusted for inflation. For 2007, the allowable deduction has
              been increased to $125,000 and the phase out limit has been set at $500,000. In
              laymen’s terms, the Act basically increased both the percentage rate at which
              items can be depreciated and the amount a taxpayer may choose to expense under
              Section 179, allowing them to deduct the full cost of the item from their income
              without having to depreciate the amount. Due to these tax law changes, $100 or
              $1 buyout lease structures, and Equipment Finance Agreements have increased
              in poplularity. You should consult your tax accountant to determine how Section
              179 may be applied to your equipment acquisition.

              Ability to Finance Soft Costs
              One of the biggest advantages that customers may not be aware is available
              to them when leasing is the ability to finance 100 percent of the total cost of
              acquiring new equipment. For the construction company that is leasing large
              equipment to be used on the job, there can be substantial costs associated with
              the delivery of the equipment as well as any training needed for new or existing
              employees. The company has the ability to include these costs in with the
              purchase price of the equipment to repay over the term of the lease, eliminating
              the need to produce a large amount of capital upfront.

              For the business that is purchasing new equipment for the network, much more
              capital is needed than the basic cost of the equipment. This purchase must
              also include extensive software investments that incur a licensing fee for each
              employee who must have access to the applications. Depending on the size of the
              business, this amount can increase rather rapidly. The IT department head will
              have a tremendous challenge when presenting the case to corporate executives
              for such implementations as large upfront costs quickly deplete a rapid return
              on investment (ROI). Bank loans tend to disallow financing for such soft costs
              while also requiring a substantial down payment. Lease financing not only allows
              for the inclusion of soft costs, it also requires no upfront costs, facilitating the
              implementation of the network, software, equipment or whatever else is needed,
              with a stable monthly payment that presents other benefits to the organization as

              Payment Stream Customization
              Lease financing products are available in a variety of options that enable an
              organization to select an option that fits their needs or even tailor an agreement
              specific to their company. For the organization that is concerned with its month-

              to-month or year-to-year cash flow needs, budgets, transaction structure or
Benefits of   seasonal fluctuations, a lease option can be customized to fit those specific needs.
              This is especially important for the company that is anticipating growth and

 Leasing      wants to ensure that any agreements entered into will not inhibit any moves for
              expansion later.

              Consider the multiple options that are available to the organization that include
              payment structures such as step-up leases, skip leases, deferred payment leases
              and master leases. While more information on each will be provided later, a
              basic overview provides the obvious benefits that each can offer. A step-up lease
              enables the organization to start with low payments that will increase over time
              so that the organization can focus its efforts on using the equipment to generate
              revenues. A skip lease restricts payments to given months of the year so the
              company can plan ahead to cover slower months or quarters. A deferred payment
              lease provides for a significant grace period before the first payment is due and a
              master lease offers a convenient way to add more equipment to the existing lease.

              Lease financing could readily be considered one of the easiest payment options
              a	company	can	use	to	acquire	equipment	or	other	items	necessary	to	operate.	
              To secure funding, lease companies generally do not require a business plan,
              audited statements, blanket liens or cross collateralization. Transactions for lease
              options up to as much as $100,000 can be approved in as little as a few days or
              even a few hours on the basis of a one page credit application form. The ultimate
              funding of the transaction can also occur in as little as one week, making leasing
              a quick way to add equipment. This type of convenience puts the organization in
              a position to be able to respond quickly to new opportunities.

              Finance Used Equipment
              If you are in the market for used equipment for your business the availability
              of finance options is reduced. This is an area where leasing really shines. Some
              leasing companies (lessors) actually focus on funding equipment purchases in
              selected industries. This allows them to intimately learn the capabilities of the
              type of equipment used in those particular industries. The benefit to you, the
              business owner is that these due to this knowledge you are more likely to obtain
              lease financing for used equipment, which otherwise you may be required to pay
              cash for.

Types of      A true lease, also considered an operating lease, is a finance agreement in which
              the leasing company retains ownership of the equipment during the lease. This

 Leases       type of lease typically has no predetermined buyout and customers are able to
              classify these payments as an operating expense. This type of lease is typically
              used for equipment that rapidly depreciates or becomes obsolete in a short period
              of time. These leases tend to have lower payments and are generally the most
              tax-friendly form of leasing. The customer will have three options at the end of
              this type of lease, which include returning the equipment to the leasing company,

              purchasing the equipment at fair market value or extending the term of the lease.
Types of   Another leasing option includes that of the finance	or	capital lease.	In	this	
           financing situation, the full purchase price plus finance costs are spread out over

 Leases    the length of the lease term. The customer will own the equipment at the end of
           the lease term for a minimal amount that can be a fixed percentage of the original
           cost or $1.00. This type of arrangement is ideal for the organization that plans on
           owning the equipment at the end of the lease term.

           One other financing option that deserves mention is the Equipment Finance
           Agreement	or	EFA. While the EFA is not a lease agreement, it has become a
           common financing tool offered by leasing companies. The agreement, paperwork,
           and process for the EFA is very similar to a lease agreement. Essentially, an EFA
           is a fixed-term commercial finance agreement with equal monthly payments.
           The borrower retains ownership of the equipment and the lessor takes a security
           interest in the equipment through a UCC filing. In other words, it is simply a
           commercial term loan agreement specifically for equipment acquisitions

           Payment Structures
           One of the best benefits of a lease is the flexibility it provides in existing payment
           structures. Many different options are available and the customer can often select
           from the following based on their specific needs:

           A skip lease is an agreement with specific payment structures that can be
           customized according to the needs of the customer. It provides the customer
           with the flexibility to determine which months there will be no payments made
           on the lease. This flexibility enables the organization to adjust to irregular cash
           flows. This type of payment structure is suitable for organizations that need a
           flexible repayment schedule such as seasonal businesses, agricultural companies,
           recreational services firms and school systems.

           A sales leaseback is a payment structure specifically designed for the customer
           who has already purchased equipment and then decides that leasing may be
           the best option. In this scenario, the company sells its equipment to the leasing
           company, which then takes ownership of the equipment and then leases it back to
           the customer. There does tend to be a time limit in which this type of transaction
           can occur and it is usually measured from the original date of purchase. When a
           company takes advantage of such a payment structure, they are able to put money
           back into the business or other investments that would appreciate over time.

           A master lease allows for the creation of separate lease schedules to
           accommodate the addition of equipment over that period of time. The master
           lease governs the basic terms and conditions and each schedule may include
           different end-of-term options and even different lengths of time. This type of
           payment structure is suitable for the company that is planning for expansion
           before the end of the term of the lease and does not want to have several separate
           leases on equipment. The master lease allows for better management of the lease
           agreement and makes adding equipment over time much more convenient.

Types of   A municipal lease provides for significantly different tax structures and details
           as compared to standard business leases. They are designed specifically for local

 Leases    and state government organizations and can be much more beneficial for that
           organization than a standard lease. The benefits, terms and conditions can vary
           according to the organization and its location. It is best that the organization seek
           the assistance of their financial advisor when considering a municipal lease.

           A step up lease is an ideal payment structure for the company who is acquiring
           equipment that will become more profitable for the business over time. Payments
           in such a structure start out very low and increase over time according to a regular
           schedule over the life of the lease.

           A deferred payment lease enables a company to put the equipment in use prior
           to any payments coming due. Such a structure allows for additional cash flow to
           be created before payments start. Deferred payment structures are useful when
           there is an extensive installation or training period involved before the company
           realizes the financial benefit of adding the new equipment. Payments can be
           deferred anywhere from three to seven months from the start date of the lease.

           A TRAC lease is a useful lease structure typically reserved for vehicular leases.
           Such a structure allows for a larger than usual purchase option at the end of the
           lease, resulting in a lower monthly payment to the business.

Buyout/    The customer has a few options to choose from when evaluating their action at
           the end of the lease term. The end-of-lease options are established prior to the

Purchase   inception of the lease. The selection that the customer makes can determine the
           payment amount over the term of the lease as well as the final ownership of the


           If the customer elects to take the fair market value (FMV) purchase option,
           they will actually have several choices at the end of the lease term. The customer
           may elect to either purchase the equipment for the fair market value at the end
           of the lease; extend the lease for a pre-determined length of time, which will be
           specified in the original lease contract; or return the equipment to the leasing
           company at the end of the lease term. When the customer simply elects to take
           the	fair market value purchase, they are obligated to purchase the equipment at
           the end of the lease term for its then fair market value.

           The customer may also elect to take a 10% Option, a 10% PUT or $1 Buyout
           option. In the 10% Option scenario, the customer has the option to either
           purchase the equipment for 10% of its original purchase price; extend the
           lease for a pre-determined length of time that will be specified in the original
           lease contract; or return the equipment at the end of the lease term. In certain
           circumstances a higher purchase option, as much as 25 percent of the purchase
           price, is available. When the customer selects the 10% PUT option, they simply
           agree to buy the equipment for 10% of its original purchase price at the end of
           the lease agreement. When a $1 Buyout option is taken, the customer purchases

           the equipment for $1 at the end of a capital lease and the title of the equipment is
           then transferred to the customer from the leasing company.
 Lease vs.   Cash Purchase
             Conventional wisdom would have the customer to believe that purchasing
   Buy       anything for the business with cash is better than financing that purchase over
             time. When taking only the purchase into consideration, it may very well be true
             that the cash purchase makes more sense. However, large capital investments
             are difficult to fund with cash. For one, the company may or may not have the
             adequate amount of cash on hand to invest in a large equipment purchase. What’s
             more, cash is not the least expensive choice for financing that many believe it to

             The cash in the business account is money that has already been earned and
             represents what is left over after taxes have already been paid. So, in effect,
             any purchase made with cash is done so with after-tax money, negating the
             anticipated savings on interest. Through the restriction of cash expenditures,
             the company can drive revenue and use the cash for marketing, advertising and
             promotion. Poor cash flow is one of the most common reasons for business
             failure and paying cash could have an adverse effect on a business’s ability to
             succeed over the long-term.

Ownership    Bank Loan
             Banks have traditionally been the primary source for business funding.
 vs. Use     When it comes to financing equipment, however, it can prove to be less than
             advantageous. Banks often require extensive paperwork before approving a loan.
             The business essentially has to prove to the bank that they not only can repay the
             loan, but also that they need the equipment in the first place. The bank will often
             require a significant down payment, as much as 20 percent of the total equipment
             cost, and does not allow the company to include soft costs in the financed

             Bank-financed equipment must be depreciated over a period of years and only
             the interest paid is deductible. Banks also often attach broad restrictions on the
             company’s ability to seek future financing without their express consent. They
             can also require that the company pledge other collateral by filing blanket liens
             that effectively secure all equipment and assets against the loan, not just the
             equipment that is being purchased with that particular loan. In addition, banks
             may also want all of the company’s commercial business, including checking and
             savings accounts with minimum balance requirements. Lease companies require

         Our goal with “Leasing 101” was to educate you on the basics of equipment
What’s   leasing, as well as the perceived and actual benefits that it can provide to
         your business. While there are other methods of financing capital equipment
 Next    acquisitions, leasing offers the best combination of flexibility, convenience, and
         value. Add to that potential accounting and tax benefits and the ability to preserve
         credit lines and cash flows, and lease financing makes sense any company that
         wants to use equipment to drive revenues and grow their business.

         If you have any questions we are here to serve you. Call us today and speak with
         one of our lease experts to find out if equipment leasing is a good fit for your
         situation. If you are considering purchasing new equipment for your business,
         give us a call and we would be happy to give you a competitive lease quote. You
         can reach us toll free at 1-800-621-6587 or online at

         We hope you found value in this report and we wish you and your business
         continued	prosperity!


                                     Strategic Business Funding
                                     206 N. Randolph St., Suite 2
                                        Champaign, IL 61820
                                       Phone: (800) 621-6587
                                         Fax: (800) 646-0984


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