To lease or buy

Kristen D’Andrea, The Daily Record Newswire

Business owners looking to acquire anything from computers and copiers to heavy machinery and vehicles often grapple with whether to lease or buy. It's a complex decision that depends on long-term objectives, cash flow and individual tax situations, among other factors.

The primary benefit to leasing is the lower borrowing cost the lessee may incur by trading depreciation to the lessor, according to Bob Lee, head of the business banking equipment finance team for Bank of America.

For instance, a company with $200,000 in taxable income that wants to buy a $1-million piece of equipment will generate immediate, near-term depreciation, he said.

"The only value to depreciation is that it reduces your tax bill," he said. In this example, the company would have created more depreciation than it could use. If a company can't fully utilize the depreciation in the near-term, it can trade the monetary value to the lessor in return for a lower borrowing cost, Lee said.

"If you can't use all of the depreciation, it's smart to trade it to the lessor," he said.

The tax position of the lessee and lessor is an important factor, as well. If the lessee is not a full-rate tax payer "They might have depletion allowance, R&D credit or just didn't make a lot of money," Lee said there is an arbitrage opportunity for the client to let the lessor buy the equipment, receive the full benefit of depreciation and trade the lower borrowing cost back to the lessee.

"It's a win-win," Lee said.

There is no advantage to trading depreciation, however, if the company is a full-rate tax payer.

"In that situation, there's no opportunity to create a benefit that hadn't been there, and they should probably think about buying," Lee said. That is, unless the obsolescence factor comes into play.

The equipment's technological obsolescence is a major consideration when deciding whether to buy or lease, said Sean O'Neill, vice president of sales for Highland Capital Corp., a subsidiary of Valley National Bank. HCC is a national lender focused on medical specialties including dentists, physicians and veterinarians. O'Neill discusses the various products HCC offers a range of short- and long-term loans and leases with doctors while determining their needs. He advises customers to consider their objectives and timelines for using the equipment. If the equipment lends itself for technological advancement, he might advise leasing; if it's a hard asset, a company might want to own it.

"Often the cost of technology goes down and it makes sense to get into a lease product where you can push the risk [of obsolescence] onto the lessor," O'Neill said. "If I own it and I'm paying for the entire cost of that asset and I decide to upgrade, it can be very costly."

On the other hand, "if I leased an office chair, because it doesn't deteriorate, I could end up overpaying if I want to continue to use that asset" once the lease is up, O'Neill said.

It's important for businesses in a lease agreement to make sure they're not paying for the asset in full, Lee said.

"If a leasing company is willing to let you pay 80 cents to 85 cents on the $1 and then give [the asset] back, that's ideal," he said. "Then you've only paid for the usage."

End-of-term flexibility to return assets or purchase them at market value is important to a lot of customers in the information technology space, according to Kevin Doyle, senior regional director for TD Equipment Finance.

"It provides some level of flexibility and allows them to structure a deal based on tax structure," he said. In general, TD customers opt for a fixed-rate structure.

"Most are locking in so their cash flow is predictable," Doyle said. "It allows companies to conserve their capital and grow their business."

Companies should consider how long they anticipate using the equipment they're looking to acquire, as well. A manufacturer who plans to use equipment for more than 10 years should buy, rather than lease, Lee said, adding the company would likely use the equipment for longer than the lessor would be willing to lease it for. Conversely, if a company plans to upgrade the equipment in four or five years, it would likely be a good lease opportunity, he said.

In other situations, if a company can make upfront payments without impinging on its cash flow and, in turn, reduce its overall interest expense, buying makes more sense than leasing, Lee said. Still, a company looking to make a $10,000 computer investment might find payments around $350 to lease over a two-year period, O'Neill said. If that same equipment was purchased and financed over five years, the payments could be as low as $190 a month. Although the payments may be about 185 percent higher with the lease option, even though the business would not be fully amortizing the $10,000, it might be an attractive option for tax benefits and protection from technological obsolescence, he said.

Bank of America offers a wide spectrum of products from fixed-rate term loans to tax-motivated off-balance-sheet leasing and everything in between. The majority of its business banking involves companies with $5 million to $75 million in sales who lean more heavily toward loans. Generally, from a need perspective, small companies should opt for leases, Lee said.

"Small companies tend to default to vanilla products," he said, noting their reasons vary and may include unfamiliarity about leasing or a negative experience with another lender. However, "when properly diagnosed, properly sold and properly structured, smaller companies should employ leasing more."

Published: Fri, Sep 19, 2014