What Is Equipment Leasing?
Equipment leasing allows business owners to rent equipment from a vendor or leasing company for a specific period of time. At the end of the lease, the company must return the equipment, renew the lease, or purchase the equipment. Leasing equipment is typically more expensive in the long-term than purchase, but can mean lower monthly payments for the business.
Virtually every successful business reaches the point where new equipment—from computers to machinery to vehicles—becomes essential. But what if you don’t have the capital on hand to pay for those necessary items? Financing the equipment with a business loan is one option, but that can require a substantial down payment and higher monthly payments.
One popular solution for business owners in this situation is equipment leasing. Under the right terms, equipment leasing can help a business with capital issues secure the equipment they need to stay competitive and grow. Even if a business has plenty of cash, leasing could still be the best choice. Find out about the basics of equipment leasing, types of leases, and the benefits of leasing.
Basics of Equipment Leasing
Equipment leasing lets you rent the equipment you need for a specific period of time, instead of buying it or seeking financing for it. You make monthly payments for a predetermined number of months, and once the lease ends, you can choose to renew your lease, buy the equipment, or end the lease and return the equipment.
Leasing has advantages and its disadvantages, of course. On the one hand, you’ll always have the most current equipment and regular equipment maintenance. On the other, equipment leasing is generally more expensive than buying outright in the long term. If you’re a new startup or a one-person business, you probably won’t benefit from leasing, but if your business is rapidly expanding, equipment leasing could be an excellent idea.
Types of Equipment Leasing
Equipment leasing can be a benefit to your small business, but you should be sure to get the right type of lease for your company. Sometimes, businesses get stuck in leases that are actually structured a lot more like equipment loans. It helps to understand the lingo around equipment leasing before you start your search for a leasing company or vendor.
There are two main types of equipment leases, capital leases and operating leases:
- Capital Lease – This is an equipment lease where the company can put the leased equipment on their balance sheet, equivalent to how it would appear if they owned the equipment outright. Monthly payments tend to be higher with capital leases, similar to an equipment loan. With this type of lease, the business is likely to buy the equipment at the end of the lease term.
- Operating Lease/Fair Market Value Lease – This is an equipment lease where the business doesn’t receive the benefits of ownership, but monthly payments tend to be lower. This type of lease works well with computers and other equipment that needs to be upgraded frequently. In this case, the business will likely return the equipment or renew the lease at the end of the term.
Within these umbrella classifications, there are different types of leases. For example, a $1 buyout lease is a common type of capital lease, allowing the lease holder to purchase the equipment at the end of the lease for the nominal price of $1. A 10% option lease is similar, but the eventual price is 10% of the equipment’s original value.
When choosing between two types of leases, think about your eventual goals. If your goal is to sustain low monthly payments, then opt for an operating lease. If your goal is to buy the equipment down the line, opt for a capital lease.
7 Benefits of Equipment Leasing
Let’s review seven common scenarios where leasing might make more sense than buying:
1. You need to stay on the cutting edge of technology.
Some companies can get by with using the same equipment for decades. Other businesses, especially in the technical space, are at a big disadvantage if their equipment becomes even the least bit obsolete.
Leasing instead of buying lets a business change out its equipment regularly. While it’s entirely impractical for most firms to buy new equipment every year or two, short-term leasing will usually allow you to equip your company with the latest hardware or machinery. If you’re looking for electronic or medical equipment, for example, a lease can often be the best choice for your business.
2. You need to spend capital in other areas.
It’s just not always a convenient time to spend a ton of money upgrading equipment. If your company has other more pressing cash needs, then leasing equipment lets you push that money you’d spend on an equipment upgrade towards another, more urgent area of your business.
3. You don’t have the capital to make a large purchase.
Because most equipment leases come with relatively low down payments (if at all!), leasing is often the best option for business owners who don’t have the cash to buy their new equipment outright. Plus, lease payments are usually significantly lower than the monthly payments attached to a business loan or a line of credit.
4. You have old equipment you’d like to sell.
If your company is looking to upgrade its existing equipment but doesn’t have the time or inclination to sell it, a lease makes perfect sense. Plenty of equipment leases will offer credit on old trade-ins. This saves you the time and hassle of finding a buyer for your obsolete equipment—and often gets you a sizeable discount on your new lease terms.
5. You want to take advantage of tax incentives.
Leasing equipment comes with some fairly serious built-in financial advantages: tax credits. Under Section 179 of the IRS tax code, leasing is often entirely tax deductible. The maximum annual tax deduction is currently set at $1 million, and business owners can deduct up to 100% of many leasing expenses, provided that they meet certain terms and don’t exceed the maximum cap.
6. You’ll get a fixed financing rate instead of a floating rate.
If you’re choosing between taking out a loan and securing a lease, keep in mind that equipment leasing offers more flexibility when it comes to financing rates. Rather than a floating rate, standard with bank loans, leasing equipment gives you a fixed rate for the term of the lease. In addition, leasing provides 100% financing—which means that it can extend to “soft costs” like training, sales tax, and installation.
7. You don’t plan on keeping the equipment for long.
If you plan to keep the equipment for at least five years, purchasing or securing a loan is probably the better option. But if you don’t need the equipment for the long haul or you’re unsure whether it’s the right piece of equipment for your needs, it makes sense to lease it.
Equipment Leasing: Your Route to Obtaining Essential Equipment
When it comes to buying or leasing business equipment or vehicles, there’s no right or wrong answer—only right or wrong circumstances. If your business falls under one of the seven scenarios outlined above, leasing equipment might be the smartest choice to make. Just be sure to evaluate your goals carefully and choose a type of lease that lines up with your business’s objectives.