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Leasing Assets as a Form of Financing

Leasing companies, as well as banks and some suppliers and vendors, will rent equipment and other business assets to small businesses. Some manufacturers have leasing agents who may be able to arrange lease terms or a credit arrangement with the manufacturer, a subsidiary company, or a specific lessor.

Leasing assets, rather than purchasing them, is a form of financing because it avoids the large downpayment frequently required for asset purchases and it frees up funds for other business expenditures. However, you should be aware that leasing from conventional lenders may be difficult for startup businesses because traditional lenders require an operating history from prospective lessees.

Here are Some Advantages of Leasing

  • Frees up cash. Many leases require little or no downpayment. Leasing thereby allows you to direct cash toward other business expenses and investments. An improved cash position can also help your ongoing ability to obtain additional debt.
  • Less debt appears on your financial statements. In a straightforward operating lease -- in which you rent assets for a set time period without an ownership interest -- neither the leased asset nor the cost of leasing appear on a balance sheet. Cash flow and expense-related financial statements will show only lease amounts as they come due. The relative absence of business debt will improve your chances for conventional loans.
  • Allows more flexibility for equipment changes and upgrades. For businesses in which rapid technology changes or new equipment is common, leasing allows you to minimize the costs of purchasing equipment that is quickly antiquated. Many leasing companies also provide for lease upgrade options or termination fees. In addition, an option to purchase a leased asset is usually available if you want to buy the asset at the end of the lease term.
  • Tax deductible. Leasing costs are deductible expenses that immediately reduce taxable income. You should compare the benefits of a lease deduction to the depreciation deduction you would obtain if you purchased the asset.
  • Landlord may help. If you are willing to enter into a long-term real estate lease for office or plant space, the landlord may be willing to finance certain improvements to the property that are necessary for your business. You can pay for these improvements through added rent over the period of the lease. This arrangement saves up-front cash and equity and does not impair your financial ratios for other financing.

Refer to our discussion of the several disadvantages of leasing.

Because more businesses are using leases, greater creativity in lease terms and purposes are becoming available. Leases can be drafted so that they resemble a long-term purchase of capital equipment. The term of the lease approximates the expected useful life of the asset and the total of lease payments is keyed to the underlying cost of the asset. The lessee pays insurance and taxes on the asset. The lessee may either be required to purchase the asset at the end of the lease, or a purchase option may be available at the end of the lease or for a stated price during the term of the lease. A service contract can usually be purchased for an additional charge.

Warning

Warning

As your ownership options/rights are increased in a lease agreement, your financial statements may have to show the lease as an asset purchase, with an accompanying listing of the asset and a liability for the amount of the "loan." These changes will negatively affect your debt/equity ratios and your net income.

Sale and leaseback. A derivative form of lease financing, this type of arrangement requires the borrower to sell valuable, fixed assets, such as equipment or facilities, to a financier who then leases the asset back to the seller. The sale generates cash to the small business for short-term needs, allows continued use of the asset, and creates a tax deduction for rental expense. A purchase option at the end of the lease period allows the original owner to reacquire title to the asset at a later date. If you want to explore sale-and-leaseback arrangements, you should definitely consult a tax professional.