Leasing equipment: Lease or buy?

David Tull, chairman of Crestmark Bank in Troy, Mich., says a company's priorities, long-term goals, and financial condition determine whether it should lease or buy equipment.

"Garden-variety financial theory says don't buy something that is a depreciating asset, or where technology and capabilities will quickly be outstripped. Lease instead," Tull asserts. "The key advantages to leasing are that it permits 100 percent financing, avoids down payments and reduces payments by stretching them out over a longer period."

Attorney Richard Contino, managing partner of the business development and advice law firm Contino & Partners and author of the Handbook of Equipment Leasing: A Deal Maker's Guide, provides a "when-to-lease checklist" to help business owners determine when leasing is appropriate.

He says equipment leasing should be considered when any of several conditions are met:

• There is a high risk that equipment will become obsolete before the end of its useful life
• The equipment will be needed only for a short period of time
• Capital resources need to be preserved
• Technical, administrative or other non-financial equipment not internally available can be more easily secured from a leasing company
• High interest rates must be paid for borrowing money
• The tax benefits resulting from the equipment ownership cannot be used
• The equipment will have a poor market value at the end of its term use

"Generally, from the largest to the smallest, all businesses are concerned with preservation of capital," explains Stephen Galop at UniCapital Business Credit Group in Miami. "With leasing, you pay for the equipment over time through its use, instead of through a large initial capital outlay." Seasonal businesses may find lease payments more flexible. "Often, you can arrange your payments so as to pay more during 'on seasons' and less during 'off seasons'."

The institutional brokerage, research and investment banking firm of Friedman, Billings, Ramsey & Co. Inc. in Arlington, Va., recently evaluated the equipment leasing industry. Its published report explains that leasing can provide a hedge against economic downturn. Leasing is more advantageous during a recession because it provides more short-term flexibility and a fixed payment structure against the risk of rising interest rates, and it alleviates the threat of insolvency due to cash flow problems.

However, an economy in expansion -- characterized by low inflation, high employment and high corporate profits -- lends itself to equipment purchases, which put cash flow to work and offer tax advantages. The business owner may deduct depreciation on the equipment over a three- to five-year term.

Buying also allows the owner to gain from any appreciation in the value of the equipment, Contino says. He cites the example of a 10-year-old river barge that may be worth more than its original purchase price.

Furthermore, at the end of a lease for equipment essential to company operations, there is no guarantee that there will be suitable replacement equipment or that the lessor will sell or re-lease the equipment back to the business owner. The prospect of losing vital equipment is like getting the rug pulled out from under you, and could place a small business owner in dire straits.