The ABCs of Technology Leasing

9/15/2005 By: Robb Aldridge

Ownership means control. What you buy is easier to manage with respect to upgrading or getting rid of equipment that is no longer adequate for the job. Purchasing can put severe demands on cash flow, however, so sometimes the budget drives the decision to lease.

Not surprisingly, leasing reverses the advantages and disadvantages of ownership. For many entities, it is easier to budget for smaller payments over time than a larger allocation for purchase. Loss of control is the greatest disadvantage; unfortunately, some leasing companies exploit this to generate extreme profits. For those who decide to lease, however, control can be increased by adding technology refresh and end-of-lease options.

What and How Long

If you plan on both buying and leasing, buy what you believe has a longer useful life, such as buildings, buses, and furniture. Items such as PCs have little or no value in a few years and even disposal can be difficult. In the IT world, soft costs, including service, training, and software, can add up to more than the hardware itself.

If cash flow is an issue, bundle all of these into a single lease contract to spread out the financial impact of the expenditures.

Match the length of the lease to the period of time you intend to use the technology. If a system will serve your needs for four years, then a 48-month lease is the most logical. When in doubt, write the lease for a longer period of time, as the longer the term, the lower the monthly payments. Also consider that at lease end, it will take time to move to new technology solutions. Writing a longer lease at the front end is usually cheaper than short-term extensions at the back end.

Payments

Match the payments to your budget. Whether monthly, quarterly, or annually, the lessor should be able to accommodate your needs. In many cases, the equipment can be delivered immediately with no payments due until your next fiscal year. It may also be possible to increase the payments over time (stepped rents) or have an annual period when no payments are due at all, such as during the summer months (rental holidays).

If the implementation will take time, consider a project finance option, wherein the lessor pays the vendors as the equipment is delivered and payments begin whenever the entire solution is in place and ready to go. Project financing also more closely matches payment outgo with the expected benefits.

Options

No one has a crystal ball, especially when it comes to technology. So consider having technology refresh options built into the lease. Technology refresh defines points in the lease when you can upgrade or add equipment to the lease or return equipment that no longer fulfills your needs. Those options should include language that defines the economics that will govern those events.

Under current accounting standards, sometimes referred to as FAS 13, leases can be shown as operating expenses rather than as debt on the balance sheet. Talk to your financial people to see if this treatment would be desirable. If so, the rapid rates of technological change for technology assets means that off-balance sheet treatment can most easily be accomplished by the use cancellation and return options. Those options allow the customer to cancel the lease or return assets in certain circumstances. Obviously, you'll want to run any such proposals by your accounting staff.

End-of-Lease Options

A true lease will usually have fair market value purchase options at the end of the initial lease term, which are often structured for accounting and tax purposes. If you think you may want to buy the equipment, ask for a cap or upper limit on that option, such as "fair market value not to exceed 15 percent." You may also want to have predetermined lease extension options, just in case you aren't quite ready to move to a new technology platform.

Whatever the equipment type, you are usually better off dealing with a lessor that has significant expertise in that area. When leasing high-tech equipment, for example, a company that makes a market in used technology equipment can usually offer better rates and more flexible terms. A company that specializes in trucks, for instance, won't be too aggressive when quoting and structuring a lease for Cisco routers and Sun servers. When in doubt, get a second quote.

Vendor Finance

Many manufacturers will have leasing options available from their own or an affiliated company, known as vendor finance. Just as car companies sometimes stimulate sales by offering zero percent and other financing programs, vendor financing will often prove to be the least expensive alternative. Keep in mind, however, that a vendor finance company is usually most interested in selling its own equipment, so if you want to maintain technology refresh options or even end a lease early and return the equipment, the company tends to be accommodating only if you stay with its products. If you try to move to a different manufacturer, it may be much less cooperative. In many cases, slightly higher lease rates with an independent lessor may be a small price to pay for increased flexibility in case you decide to move to other technology platforms.

Sanity Check

A lessor will typically quote a lease to generate an overall yield that is commensurate with your credit rating as well as the expected residual value of the equipment. Most high-tech equipment suffers from fairly rapid technological obsolescence, and as a result, a lessor will not expect much yield contribution from the value of equipment it receives at the end of a lease. If you do a present value cost calculation, therefore, the lease payments with a nominal residual expectation will likely fall in the same general range as your cost of funds if you went and borrowed the money for an outright purchase.

Unscrupulous lessors will win the business with low rates and then take advantage of the customer with difficult or impossible end-of-lease provisions. For example, some leases require all of the equipment to be returned at the same time, perhaps in a single day. Such terms and provisions are all too often used to extort unreasonable fees from a lessee at the end of the lease term if the lessee is late returning equipment.

Leasing can be an effective way to get the technology you need in a manner that is significantly easier on your budget. Before entering into a lease, however, ask for the terms and conditions which are important for your institution, including suitable technology refresh and end-of-lease options. Remember, the lease payment itself can be just part of the equation.

Robb Aldridge is a leasing specialist for Solarcom.

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