For CEOs, it seems as if requests for
new phone systems, computers,
copiers and networking equipment are an everyday occurrence. Certainly, a
continuous investment in office and
communications equipment is necessary in order for a company to remain
competitive.
How to finance capital equipment can be
a major decision for CEOs. Many choose
leasing as a preferred method. Each leasing company has its own lease agreement.
So knowing the most advantageous terms
in a lease agreement is vital when it comes
time for the CEO’s selection.
“Equipment leasing can be an attractive and flexible alternative means for a
business to acquire equipment rather
than paying cash or borrowing money,”
says Sandra L. Shippey, partner with
Procopio, Cory, Hargreaves & Savitch
LLP. “There are some pluses and minuses in lease agreements that CEOs should
be aware of before they sign on the dotted line.”
Smart Business spoke with Shippey
about the advantages of leasing and what
CEOs should know before signing a lease
agreement.
What type of contract is an equipment lease?
An equipment lease is generally a ‘net’
lease where the lessee agrees to lease the
equipment from the lessor for a noncancelable fixed term of years, and the lessee
must pay rent, taxes and insurance and
agree to maintain the equipment throughout the lease term. At the end of the lease,
the lessee either returns the equipment to
the lessor in the condition required by the
lease, purchases the equipment pursuant
to a purchase option contained in the lease,
or renews the lease for an additional term.
What are the advantages of leasing equipment versus purchase or direct financing?
- Preserves working capital: Generally,
lease financing is 100 percent financing, so
there is often no down payment required
from the lessee, which will result in the lessee preserving working capital. This is particularly beneficial to emerging companies
that want to conserve their limited cash
resources. - Lower rates: Often, the lessee will
pay lower rates for a lease than a loan
because the lessor, as the owner of the
equipment, will be able to take advantage of accelerated depreciation tax benefits and pass on at least some of the tax
savings from those tax benefits to the
lessee in the form of reduced rent.
Again, this will help a business conserve
its working capital through the life of the
lease. - Fewer covenants: Generally, loan transactions contain significant restrictions on
management’s decisions and contain financial and other restrictive covenants on the
business itself. Usually, but not always,
equipment leases contain less restrictive
business and financial covenants. - Flexibility in structure: An equipment
lessor can provide many different types of
leasing structures that will provide flexibility to a potential lessee such as reduced
lease payments in the early years with
higher lease payments in later years as the
business grows to increase cash flow; options to upgrade the equipment during
the lease term; different purchase options
from mid-term early purchase options to
end-of-term purchase options at a price
equal to the equipment’s fair market value
or a predetermined fixed amount; and
renewal options.
What should CEOs be aware of when reviewing a lease agreement?
Usually, a lease proposal or term sheet
will be provided by a potential lessor that
describes the basic structure of the lease
that will be documented in more detail in
the actual equipment lease agreement.
Lessees should be particularly aware of
the following issues that are generally
negotiable.
First, review the proposed structure
including the lease term, rental payment
amount, amount of casualty and termination values, and minimum insurance
requirements so that the structure adequately meets your business requirements.
Second, note whether any purchase
options or renewal options are offered and
whether you might want to put any limits
on fair market value purchase options and
renewal options.
Third, see if any business or financial
covenants will be applicable so you can
determine whether they will be acceptable
from a business perspective.
Fourth, notice if any tax indemnification
will be required from you.
Fifth, see if you are allowed to self-insure
against any risks, which is important if this
is currently part of your strategy.
Finally, find out the required return conditions for the equipment and whether
they are acceptable from a business
standpoint.
With such a competitive market, it may
be possible for CEOs to negotiate successfully on many of these points and achieve
the best terms for their business.
SANDRA L. SHIPPEY is a partner in the law firm of
Procopio, Cory, Hargreaves & Savitch LLP. Reach her at (619)
515-3226 or [email protected]. For more information, visit
www.procopio.com.
