Charter Capital

Articles

Below is a list of articles that discuss the pros and cons of leasing, and some of the things you should be aware of once you have decided to lease. Charter Capital can also structure an equipment financing agreement if leasing is not the best option for your company.

Got a question? Ask the Lease Doctor.

What is a lease?
What are the advantages of leasing?
Is a lease better than a loan?
Is a lease better than cash?
Should I lease with a broker or a bank?

What are the disadvantages of leasing?
Leasing Horror Story

Lease Products
Lease Process
Lease Rate
Lessee Responsibilities
End of Lease Options
Before You Sign Anything!

Selecting a broker or financial intermediary

Downloads:

• Process Datasheet
• Financing Products Datasheet
• Advantages of Leasing

What is a lease?
An equipment lease is a legal, binding and generally ‘non-cancelable document’ which details an agreement between two parties, the Lessor (the party that owns the asset) and the Lessee (the party that uses the asset.) The Lessee chooses the asset they wish to use and the vendor they want to supply it. They also negotiate the purchase price and performance requirements directly with the vendor of their choice. The Lessor, on behalf of the Lessee and at the Lessee’s instruction, purchases the specific asset from the specific vendor.

The Lessee agrees to keep and use the asset for a specific time period defined as the lease term. During this period the Lessee must pay a pre-determined periodic rental (usually monthly), pay any and all taxes or other equipment assessments, maintain the required insurance, and care for the asset so that it remains in good working condition. The Lessee must use the asset for commercial purposes.

Although all situations are unique, once the asset has been ordered by the lessor, the lessee may not withdraw from the agreement and is obligated to perform its duties and responsibilities as defined in the lease agreement for the full lease term.

Once the lease term has expired and providing the Lessee has performed their obligations as defined in the lease they generally have three options. They may return the asset to the Lessor in good working condition. They may, with the lessor’s consent, renew the lease for another specific time period. They may purchase the asset for a pre-determined amount, a negotiated amount or the fair market value at that time.

The equipment lease is generally considered a highly flexible financial product and frequently the term, the periodic rental amount and end of lease options may be modified or structured to accommodate almost any desired situation. Remember to get all agreements, including end of lease options in writing.

Advantages of Leasing
Equipment leasing is the fastest growing type of capital equipment financing in this country. Generally speaking it is easier to obtain and more flexible than traditional types of financing and it may, if structured properly, provide the Lessee with certain unique tax or accounting benefits. It is not for every company or for every situation. It is important that if you enter into a lease you do so for the right reasons and with the right structure. We hope the following will help you decide if leasing is right for you.

The major advantages of leasing capital equipment are:

Expanded Credit Availability
Avoidance of Financial Restrictions
Clarity of Specific Uniform Commercial Code Filings
Flexibility of Structure
Small Initial Cash Outlay
Rent Expense
Warranty Pass Through
Simplified Credit Process

Expanded Credit Availability
Provided the lease is structured properly the ‘lease debt’ does not have to be shown as a direct liability on your financial statements and consequently may allow you to preserve your borrowing availability with your bank and other creditors. This may also result in improved debt-to-equity and earnings-to-fixed assets ratios thereby improving how the lending community views your company in general. Certain types of equipment leases may be obtained with a simple one-page application rather than pounds of financial data.

Some bankers and other commercial lenders may consider your leasing debt when qualifying you for a new loan or credit line. A good idea is to qualify for your commercial borrowing needs first and then use leasing to supplement your borrowing capacity.

Avoidance of Financial Restrictions
Many bank, commercial loan and credit line agreements significantly restrict additional borrowing or financing. Some of the typical restrictions are:

• In some instances a borrower must obtain the permission of an existing lender to do business with any other lender.
• In some instances loan agreements require that the Borrower maintain a certain level of compensating balances at the lending institution.
• In some instances loan agreements contain requirements that the Borrower provide periodic financial information and that certain specific financial ratios are maintained.

Many lending agreements provide that a loan or other type of financing may be ‘called’ if these types of provisions are not complied with. Equipment leasing, as a rule, does not have these types of restrictions or provisions.

Clarity of Specific Uniform Commercial Code Filings
Many banks and commercial finance companies that finance capital equipment acquisitions will file an ‘all encompassing’ financing statement with the Secretary of State in the state where the asset is located and in the state where the business is registered. Generally these filings, which are part of the Public Record, are very broad and may convey to the bank or other commercial lender an ‘interest’ in any and all of the other assets of the business. The effect of this type of filing is to create a lien on all your assets in the favor of the bank or commercial lender. Once this is done you may not borrow against or sell those assets without your lenders specific permission. Equipment leasing companies also file financing statements with the same agencies, however, these statements are generally very ‘specific’ with regard to the asset being financed and are done for information purposes only. Their interest rests solely with the asset they are financing and does not extend to the general assets of the company.

Flexibility of Structure
Leases may be structured to accommodate a business’ individual cash flow requirements. These structures match the specific business cash flow with the debt service on the lease. Some examples are:

• Deferred Rental Payments — This program provides the Lessee with an initial period at the beginning of the Lease, usually the first three to six months, that requires only token rental payments.


• Seasonal Rental Payments — This program provides payments that are tailored to the seasonal cycles of some businesses. In essence, the lease payments are greater during busy periods and lower during slower periods.


• Balloon Payments — This program creates lower monthly rental payments by adding a final lease payment that is greater than all others. Generally, this final payment is equal to ten or twenty percent of the original equipment cost while most normal lease payments will be between 2.5% and 3.5% of equipment cost.


• Quarterly Rental Payments — This program provides for four equal quarterly payments. Although there is no economic benefit to this structure, it may be helpful for companies that work on cost reimbursement contracts.


• Unequal Periodic Rental Payments — This program provides for any reasonable combination of unequal rental payments through the term of the Lease. This program may be useful for long term projects in which the equipment being leased will be used for specific periods during the Lease term.


• Step Up Rental Payments — This program provides a lease structure with rental payments starting at a low amount and periodically increasing throughout the lease term.


• Step Down Rental Payments — This program provides a lease structure with rental payments starting at a high amount and periodically decreasing throughout the lease term.

Small Initial Cash Outlay
Equipment leases generally do not require a down payment, as is the case with most loans. The cash, which is required at inception of an equipment lease, is generally applied to periodic rental payments thereby reducing your outstanding balance. This is distinguished from borrowing or financing because leasing can provide 100% financing while borrowing generally requires a down payment of between 10% and 20% of the amount requested thereby only providing 80% - 90% financing.

Some Lenders require Advance Rentals, some require Security Deposits and some require a combination. Most Lenders do this for accounting reasons as they may have the use of the cash immediately without recognizing the income until the very end of your Lease. This is not necessarily a bad thing for you, but you should know if you are making a rental payment or giving a security deposit. If you are giving a security deposit, do not forget to ask for it back at the end of your Lease. Many Lessees simply forget.

Rent Expense
Provided the lease is structured properly you may be able to deduct the entire rental payment as a current operating expense for financial reporting and for income tax purposes. This can reduce your overall tax liability and therefore reduce the ‘real cost’ of acquiring equipment.

Warranty Pass Through
Although the lessor is the owner of the asset the Lessee will have the full benefit of all manufacturers and seller’s warranties and guaranties.

Simplified Credit Process
An equipment lease is generally easier to obtain than an equipment loan. It is not uncommon for leasing companies to provide up to $75,000 in financing with only an application. Some leasing companies will go as high as $150,000 on the same basis. Most banks and commercial lenders require a complete financial package consisting of several years’ financial reports and tax returns on the business and the principals.

Lease vs. Loan
Pick up most leasing company brochures, read any lease marketing books, visit many leasing companies web sites and you’re likely to find, in one form or another, "why leasing your equipment is much better then financing it through your bank". The reality is that each business is unique and the answer to "should I lease it or finance it at my bank?" is … maybe. It depends upon your business, the prevailing economic condition of your business and which bank you bank with.

Lease vs. Cash
Whether you are starting a new company, expanding an existing facility, or simply acquiring new technology, the method used to acquire assets can have a profound impact on your business. The three most common methods of asset acquisition are paying cash, bank loans and leasing. Although purchasing for cash is universally regarded as the least expensive choice, you should carefully consider other options and the overall costs and effect on your business before you reach for that checkbook.

It is safe to say that most businesses intend to grow in strength and scope and that those objectives generally guide business decisions and define the term 'success'. It is commonly accepted within the financial community that the most prevalent reasons for business failure are insufficient capitalization and the improper management of cash flow. If we accept those premises, paying cash for capital asset acquisitions may well have an adverse effect on a businesses ability to succeed. Conversely, financing in general, specifically leasing can, when used intelligently, be a very effective management tool and enhance chances for success.

According to the U.S. Department of Commerce, approximately 40% of all capital equipment acquisitions in the US ($700 billion in 2001) are leased. Furthermore, the Equipment Leasing Association of America reports that over 80% of U.S. businesses lease some or all or their capital assets. The basic assumption that CFOs and business owners make is that benefit is derived from the use rather than the ownership of assets. Therefore, available or excess cash is spent on things which are not traditionally financed such as sales, marketing and personnel, while financing and increasingly leasing is used to acquire depreciable assets such as equipment.

An important factor to consider in financing asset acquisitions is the potential effect on your business' ability to borrow in the future. Small business owners are sometimes unaware of the potential consequences. Most creditors and especially banks will establish a limit on the amount of credit they are willing to extend. This is simply a good and prudent business practice. The major elements used to make this evaluation are cash flow, credit habits, earnings and the general financial condition of the business under review. The general financial condition and the evaluation of assets are the tricky areas. When a creditor reviews your financial statement and sees $25,000 in cash it is obvious that asset is worth $25,000. However, if you take that cash and replace it with a $25,000 computer system the creditor knows that included in the cost of that system was sales tax, sales commissions, shipping, warranty allocation, distributor profit, and manufacturer's profit. The creditor is likely to allow for soft value and will generally reduce the value of the asset by perhaps as much as 50%. In the case of a computer system, the allowance for soft value may be greater. The impact of this reduction is significant. If that asset value is reduced by $12,500 and your business can borrow at six times equity, the cash purchase has effectively reduced the ability to borrow by $75,000.

Another important consideration is the national economic environment. In the early 1980s when the prime rate rose to 21% any type of financing was astronomically expensive, if it was available at all. Many of the loans made were pegged or fixed at these levels and when rates came down many lending institutions had windfall profits. The borrowers were stuck. Cash was a very intelligent choice at that time and those businesses with reserves were not as adversely affected by the rate gyrations.

However a business chooses to acquire its operating assets, it is essential to retain availability and capacity. Business growth is rooted in the ability to have choices and to take advantage when opportunity presents itself. The age old adage was never truer CASH IS KING.

Should I lease with a broker or a bank?
The following is presented for your information and to assist you in answering this question for your business. Of course we are somewhat biased and hope you will choose to lease.

Rates
Soft Costs
Down Payments
Compensating Balances
Fixed - Floating Rate Structure
Restrictive Covenants
Fixed Term Contracts
Blanket Lien
Simplicity
Availability
The Most Important Reason

Rates
Bank financing rates are generally lower than leasing rates. Unless your lease is structured to allow you to take advantage of the potential tax benefits of a lease, it may cost you slightly more to lease over the long run.

Soft Costs
Bank financing will generally not permit you to finance soft costs associated with equipment purchases. These costs may include tax, shipping, installation, training, service contracts and in some cases software. Leases will normally include all or some of these soft costs.

Down Payments
Bank financing normally requires a down payment of between 10% to 25% of the equipment cost (which may not include soft costs mentioned above). Lease financing will generally require the first and the last rentals in advance. This would be approximately 4.5% to 7.5% of the equipment cost.

Compensating Balances
Banks frequently require that customers maintain compensating balances in order to qualify for their low rates. This not only provides the bank with an inflated rate (which you can not deduct as an operating expense ) but ties up your most precious asset …Cash.

Fixed - Floating Rate Structure
Banks would much rather lend on a floating rate basis rather than a fixed rate basis. This transfers the risk of interest rate fluctuations from the bank to you.

Restrictive Covenants
Bank loans of any nature generally contain restrictive covenants. These can include a requirement that your business maintain certain minimum financial ratios, a requirement that you obtain their permission to borrow or lease in the future, a prohibition from future borrowing completely, or a restriction as to who you may borrow from or how you may borrow in the future. It is not uncommon for lending agreements to also contain a call provision. This can allow your bank to demand that you pay off your loan if your business isn't doing as well as the bank thinks it should, if the bank is sold, if they decide that they no longer wish to support your industry segment or if they simply wish to lend the money to somebody else. Equipment leases do not contain such clauses.

Fixed Term Contracts
Banks would prefer to lend to you on a revolving basis rather than a fixed term basis. This is very good for the bank and potentially very bad for the borrower. If you borrow on this basis or your loan can be called or if your loan has to be renewed annually it must be accounted for and therefore reported on your financial statements as though it were a CURRENT LIABILITY rather then a LONG TERM DEBT. This can have a disastrous impact on how your balance sheet is interpreted by creditors, suppliers and your customers. If a lease is structured properly it may not be necessary to report it on your financial statements at all.

Blanket Lien
Banks will very often file a blanket lien when doing any sort of business financing. This essentially gives to them a lien on all your business assets and puts that fact on the Public Record. Most leasing companies file a UCC-1 financing statement which simply identifies the specific assets being leased as being the property of the lessor.

Simplicity
Due in part to the increased regulation and in part to the traditionally conservative nature of banks, a complete financial presentation is usually required to obtain any sort of financing. Leasing companies today routinely provide up to $75,000 and in some instances up to $150,000 in equipment financing with a single page application.

Availability
Banks will generally establish a maximum borrowing limit for their customers that borrow. All lending that the bank does to that customer or it's principals will apply to that lending limit and therefore reduce the availability of future borrowing. While leasing companies establish a similar limit, it is in addition to bank borrowing and tends to increase the amount a business can borrow.

The Most Important Reason
Perhaps the most important reason to consider leasing as an alternative to borrowing from your bank is the ever present unexpected event. Bank borrowing is an excellent business tool and should be cultivated and preserved. At least a portion of your availability should be held in reserve for the unexpected expense or opportunity. If you use it up it may not be available when it's really needed.

What are the disadvantages of leasing?
Although equipment leasing is the fastest growing method of financing for capital equipment acquisitions in this country it simply is not a panacea and does not work for every company or every situation. Generally equipment leasing can be used most effectively by those businesses that are growing and profitable and least effectively by those businesses that are shrinking or suffering losses.

The major disadvantages of equipment leasing are:

• Overall Cost - An equipment lease may be more expensive than other types of asset financing when the potential tax implications are not considered.


• Commitment of Term - Despite the popular misconception, once initiated most equipment leases may not be terminated before the original term is completed. Sometimes they may be paid off early, but the Lessee may obligated for the full payment of all rentals.


• No Equity - Although under the conditions of most leases the entire asset cost is repaid over the term, the Lessee does not automatically develop or accrue equity in the asset. The lessor owns the asset and the lessor enjoys all benefits of ownership until or unless the Lessee exercises an asset purchase.


• Taxes and Maintenance - Most leases require the user, Lessee, to remit all property taxes, maintain property damage and casualty insurance and generally maintain the equipment in accordance with the manufacturer's recommended schedules and procedures.

If the tax benefits of an equipment lease are important to your decision, be sure that you review the general lease terms with your accountant or other tax adviser. The IRS may disallow your treatment if they conclude that you lease is really a conditional purchase.

A Leasing Horror Story
by Rick Wilbur

Not long ago, I was playing in a golf tournament with a group of men, most of whom I didn’t know. The first round I was paired with a fellow I had not met before, but who seemed like a good enough guy. We played a few holes, cheering for each other to do well and creating an overall feeling of camaraderie. Eventually, we got around to the obligatory "where are you from?", "what do you do?", "what’s your handicap?" and so on. When I told him that I was in the equipment leasing business his smile disappeared and was replaced by a distinctly sour expression. The light banter that had been present during the first few holes also disappeared. Although I was a little put off by this abrupt change in his attitude, I asked what had caused it. After a thoughtful moment, he let out a sigh and explained that he had just had a particularly frustrating and expensive life lesson involving an equipment leasing company. Simply the thought of that experience annoyed and disgusted him all over again. He apologized and we dropped the subject without further discussion. We both played well and had a very enjoyable round of golf.

Later that day we met for a drink at the hotel bar and proceeded to talk about our game and how we had ‘ham and egged it’ to tie for first place. We talked baseball, basketball and eventually...leasing. It turned out that he had leased a telephone system a few years earlier, made his payments timely, sent in his property tax when due, and did those things he was required to do under the agreement. When he mailed in his final lease payment he included a letter asking what he needed to do to exercise his option to buy the equipment. He had always intended to purchase the equipment and in fact had negotiated to do so before he ever signed his contract. The negotiated price was $1.00, commonly referred to as a "bargain option", and was evidenced by a letter signed by the General Manager of the leasing company.

After a week without a reply to his letter he called the leasing company and was referred to a residual clerk. He had barely finished telling the clerk why he was calling when the clerk rattled off what sounded like a very practiced response. In essence and much to his astonishment, he had forfeited his option because he hadn’t advised the leasing company of his intention to exercise it in accordance with the agreement. The clerk proceeded to quote him three separate paragraphs in the lease documentation. Sure enough when read together these three paragraphs required him to send a certified letter not less then six months prior to the expiration of the lease term advising of his desire and intention to actually buy the equipment for $1.00. To add insult to injury, the clerk advised him that because he hadn’t complied with this requirement, the lease had automatically renewed and that he would now be responsible for twelve more payments. The story went on to describe several failed attempts to speak with the leasing salesperson (who, he found out later, no longer worked at that company), several failed attempts to speak with the General Manager (who, he found out later also no longer worked for that company) and several calls to the principals of the business, who simply would never come to the phone. It continued with letters, lawyers, credit reporting problems and finally a lawsuit …. which he, unfortunately lost. The final tally was, instead of paying $1.00 for a telephone system that he had actually paid, my new golf friend paid $11,000 in additional or extended rentals, approximately $600 in late fees, in excess of $3000 in legal fees and untold hours of wasted time and effort. Not a pretty story and unfortunately not an uncommon one.

The real question was why this fellow chose to do business with that particular leasing company in the first place. Since I’ve been in this business for a very long time I thought I knew the answer, but I asked it anyhow. The answer as expected was
"They had the lowest rate." Apparently not in the long run.

I bought the guy another drink and we talked ‘golf’ for the rest of the evening.

NOTE: This story is far more common than most business people might expect. There are a number of leasing companies that simply stated, operate by a different set of rules than most and that have an entirely different objective than initially apparent. Before you sign on the dotted line and before you send any company a fee or deposit, make sure that you know exactly what your responsibilities are, exactly what you are agreeing to and exactly who you are dealing with. Then you can concentrate on really important things……. Like your golf game

Click here for a list of questions to ask a leasing company before you sign.

Lease Products
Two of the major equipment leasing benefits are the structure diversity and the various accounting and tax consequences of those structures. We have detailed below some of the more common structures and lease types

PRODUCTS

• APPLICATION ONLY TRANSACTIONS - single transactions may be approved up to $75,000 with only a one-page short form application and in certain circumstances that amount may be increased to as much as $250,000. For well-established businesses multiple transactions may be done together in increments of $75,000 or less.


• SOFTWARE ONLY TRANSACTIONS - for well-established business transactions up to $75,000 in software may also be approved with a one-page short form application. Larger transactions for ‘software only’ may be considered but will require a complete financial package. Generally, software transactions command a slightly higher rate.


• STEP PAYMENT TRANSACTIONS - step-up or step-down leases are structure variations. Step-up leases begin with lower then normally amortized monthly lease payments that increase or ‘step-up’ over the lease term. The steps may be created at any point during the term but are most commonly done semi-annually or annually. Step-down leases are structured in the same way but begin with higher than normally amortized monthly lease payments and decrease over the lease term.


• SKIP PAYMENT TRANSACTIONS - typically these transactions simply skip one monthly lease payment during the year. This means that only eleven lease payments are made per year. In some cases, this does not effect the overall lease term, but does effect the payment amount. In other cases the term is extended one month for every skipped lease payment. This generally has little effect upon the amount of payment.


• 90 DAY CONTACT PAYMENT TRANSACTIONS - in some instances the acquisition of new equipment will not positively impact a company’s cash flow until the equipment has been in place for a period of time. This product allows the lessee to make token or contact payments for the initial three months of a lease thereby creating a cash flow cushion.


• SEASONAL or CYCLICAL TRANSACTIONS - in some cases, businesses experience predictable variations in their revenue stream or their cash flow. These variations may result from seasonal or market conditions. This product is specifically designed to match the lease payments to the lessee’s ability to pay. It allows lease payments to be lowered during those periods when cash flow is reduced.

The Lease Process
Equipment leasing is often considered complicated and mysterious. In reality it is a simple and efficient method of obtaining financing for equipment acquisitions and far easier to obtain than more traditional types of commercial financing. The real key is to understand that leasing equipment is very similar to leasing office space or an apartment. The Lessor owns the equipment and the Lessee contracts for the use.

The following outlines a generic lease process. While no two companies operate exactly the same way, most leasing companies will employ very similar practices.

STEP 1 - You select equipment and vendor
STEP 2 - Lease application
STEP 3 - Credit evaluation
STEP 4 - Approval in writing
STEP 5 - Contact equipment vendor
STEP 6 - Issue purchase order
STEP 7 - Signing documents
STEP 8 - Accept delivery of equipment

STEP 1 - You select equipment and vendor
The Lessee selects the equipment they want, the vendor or supplier they want to supply it and negotiates the best price with that vendor or supplier. The Lessee should also find out if the vendor requires any advance payment or down payment, if all the equipment will be delivered at the same time and approximately when that will be.

It is very common for the leasing company to not only approve the credit of the Lessee, but the vendor and the equipment as well. This is done to protect the lender and you, therefore, accurate information is important.

STEP 2 - Lease application
The Lessee submits an application to a leasing company and provides the credit and other information required by the leasing company to approve the amount and type of financing request. The Lessee should also provide a good and accurate description of the equipment, detailed information on the vendor they have selected, any pre-payment requirements and delivery schedules.
It is wise for the lessor to know exactly what the lessee wants and the lessee to know exactly what the lessor is capable of providing before the process goes beyond this point.

STEP 3 - Credit evaluation
The leasing company conducts a credit investigation and evaluation. They will consider the Lessee’s business credit history, the principals credit history, the industry, the equipment requested, the vendor and the payment terms. They will evaluate the strengths and weaknesses and advise the Lessee if they will be able to approve the amount and type of financing requested.

STEP 4 - Approval in writing
Once the leasing company ‘approves’ the proposed transaction they convey that approval including all major terms and conditions to the Lessee. This should be done in writing. The Lessee indicates their acceptance or rejection of the terms of approval. If they accept these terms they should evidence their commitment to use the financing provided by signing a Commitment Letter and giving the lessor a ‘good faith’ deposit which should be applied to the lease when it is consummated. When a leasing company requires a ‘good faith’ or other deposit, the terms and conditions for the disposition of that deposit should be clearly stated in a document signed by both companies. Generally speaking these deposits are returned in full if the leasing company is unable to proceed with funding and is generally retained if the Lessee fails to complete the transaction or causes the transaction not to complete.

This step is often skipped in the ‘small ticket market,’ generally defined as transactions under $1,000,000, however, it will benefit both the lessor and the lessee.

STEP 5 - Contact equipment vendor
Once the Lessee and the leasing company have agreed upon terms, the equipment vendor or supplier is contacted, advised of the approval and asked to issue a pro-forma invoice or equipment order form detailing the exact equipment configuration and the exact cost. Once the leasing company receives this information they will produces lease documents and send to the Lessee for execution.

Some leasing companies may ask a Lessee to execute a set of documents before the transaction is actually approved. This is usually an attempt to ‘lock up’ the deal and eliminate competition. It is also a tactic that is frequently used to obtain money from the Lessee that is almost never returned.

STEP 6 - Issue purchase order
Once the leasing company receives the properly executed lease documents and a check for the advance rentals or security deposits, they will issue their Purchase Order to the equipment vendor or supplier. This part of the process obligates the leasing company.

STEP 7 - Signing documents
The lessee signs all documents with the exception of the DELIVERY & INSTALLATION RECEIPT or ACCEPTANCE NOTICE. This document is held until the equipment has been delivered by the vendor, has been inspected by the lessee and works in accordance with the lessee's expectations.NOTE: By signing this document the lessee is indicating their acceptance of the equipment and instructing the lessor to pay the vendor.

STEP 8 - Accept delivery of equipment
Once the equipment is delivered by the equipment vendor or supplier the Lessee will be contacted and asked to verify their acceptance of the equipment, confirm their understanding of the lease terms and authorize payment to the vendor. Remember the Lessee is required to insure the equipment and either list the leasing company as ‘additional insured’ or ‘loss payee.’ When this part of the process is complete the Lessee’s equipment vendor or supplier is paid and the lease starts.

As stated above, not every leasing company will follow this exact process. It is important to know what your leasing company will do and how their process might differ. Feel free to copy this page and use it as a guide.

Types of Leases

1. FINANCE LEASE or MONEY OVER MONEY LEASE - the most commonly used lease in the small ticket market. This is a lease type that requires the lessee to remit payment of lease rentals, which total the asset cost, plus the lessor’s required profit. It is non-cancelable, requires the lessee to pay all taxes and other assessments, requires the lessee to provide insurance, and to maintain the asset according to the manufacturer’s guidelines. It is anticipated that the lessee will acquire title to the asset at the conclusion of the lease term.
2. CAPITAL LEASE - a lease type which is treated as a purchase on the lessee’s books. Capital Leases may be identified by one of the following characteristics:
   
   • The lease term is equal to or greater than 75% of the estimated useful life of the leased asset
   
   
   • Title to the asset is automatically transferred to the lessee at the end of the term
   
   
   • Title to the asset may be obtained by the lessee for a bargain option at the end of the lease term
   
   
   • The present value of the required lease payments are equal to or greater then 90% of the estimated fair market value of the asset at lease inception
3. MASTER LEASE - a lease type in which the parties detail the terms and conditions under which leased assets will be used but do not address the periodic payment requirements. These requirements are addressed in a separate document that becomes an addendum to the lease. A Master Lease may have several addenda, each one dealing with a separate asset acquisition.
4. OPERATING LEASE – a lease type that is not a CAPITAL LEASE. This lease, from a financial reporting perspective, has the characteristics of a true rental agreement and meets certain criteria established by the FASB (Financial Accounting Standards Board). OPERATING LEASES are not required to be reported on the lessee’s financial statements. The criteria for qualifying as an OPERATING LEASE under FASB13 are:
   
   • Title to the asset may not automatically transfer to the lessee at any time during the lease term or immediately after the lease term
   
   
   • There is no provision for a bargain purchase option
   
   
   • The lease is non-cancelable for its term and that term is less than 75% of the economic life of the asset
   
   
   • The present total value or minimum lease payments when discounted at the interest rate implicit in the lease is less than 90% of the asset’s fair market value
5. SALE-LEASEBACK - a lease type in which an asset that is owned by the lessee is sold to the lessor and then leased back to the lessee. This type of lease is generally used when the lessee desires additional cash for its business.
6. TRAC LEASE - a lease type, which is tax oriented and used exclusively for titled motor vehicles. TRAC derives its name from a clause in the contract, which is the terminal rental adjustment clause. This clause adjusts the residual value of the vehicle based upon usage.
7. TRUE LEASE - a lease type that qualifies as a lease under the guidelines as established by the Internal Revenue Code.

Lessee Responsibilities
The lessee has possession of and the right to use the lessor’s asset for the full lease term, provided they do not default under the terms of the agreement. Although lease documentation differs from lessor to lessor, the general lessee responsibilities remain the same. If you lease equipment you agree to:

• Make all periodic rentals when due
• Pay all taxes or other assessments on the leased asset when due
• Maintain all insurance coverage as described in the lease agreement
• Maintain the leased asset in good working order and to do any maintenance required or suggested by the manufacturer
• Maintain the leased asset at the location stipulated on the lease and obtain the Lessors consent before moving that asset to another location
• Use the leased asset for a commercial purpose
• Abide by all other obligations that are detailed in the Terms and Conditions of the Lease
• Abide by the end of term option agreed to by the parties

Lease documentation may be very complex and differs from lessor to lessor. It is very important to have it carefully reviewed by a person familiar with legal documents and to have a very clear understanding what is required. Special attention should be paid to the end of term options and what specific actions the lessee must take to keep these options open and enforceable.

End of Lease Options
The end of lease option selection may have a significant impact on the economics of your lease and may effect the way you must account for your lease in your financial reporting and tax preparation. To fully understand the various options and their consequences you should discuss this with an accountant familiar with lease accounting or an experienced leasing professional.
At the end of the original lease term the lessee generally has three options. They are:

1. Return the leased asset to the lessor in good condition and working order
2. Renew the lease for a specific period of time or on a month to month basis or
3. Purchase the leased asset for a pre-negotiated amount or its fair market value at that time

The asset purchase aspects of a lease should be carefully reviewed before entering into the agreement. The lessee should have an absolutely clear written explanation of what their option is, what they must do to exercise it, how the amount of the option will be calculated and what events could cause this option to change or be voided.

Some leasing companies employ deceptive language cleverly hidden in the Lease and other documents that require the Lessee to perform some notification at a specified time before the Lease term has expired. If this window is missed or notice is not rendered as specified in the lease, your lease automatically renews for a period of time, sometimes as long as a year.

Before You Sign Anything!
Questions to ask the leasing company.

When negotiating an equipment lease and choosing a leasing company to work with, it is absolutely essential that you know what you are agreeing to and what kind of people you are working with. Below are several questions you should ask before making a decision. We also suggest you listen to the leasing salesperson you are working with to determine if these questions are dealt with easily or if they present a problem. If you do not get straight answers to all these questions you should be careful.

Whatever your leasing company agrees to verbally, they should agree to in writing. If they are not willing to do so, consider looking elsewhere.

Do you issue Pre-Approvals?
Is my lease request formally approved?
Do you require a deposit before you formally approve my credit AND the terms that I have requested?
What is the exact amount of the monthly rental?
What is the exact equipment acquisition cost used to determine this rental?
What is the lease factor?
How many Advance Rentals are required for this Lease?
What fees or other costs are we required to pay and how much are they?
What is my Purchase Option in dollars?
Exactly what must I do to exercise my Purchase Option?
Is there an Automatic Renewal clause in the Lease?
How do you handle complaints from your customers?
Remember!

Do you issue Pre-Approvals? If so, exactly what does it mean?
Many less ethical companies employ a tactic called the Pre-Approval. If you think about it, the term means 'before approval,' but the way it is used implies that an approval has been issued before one actually has. This is very deceptive and is most often used to get a lessee to send a check to the leasing company or to sign a set of documents before the leasing company is truly committed to doing the transaction.

Is my lease request formally approved? If so, how long is the approval valid?
It is not only a right but also smart to get your formal approval in writing. The written approval should detail all aspects of the approval, any contingencies and how long the approval will remain valid. These aspects should include:

1. The amount of your approval
2. The lease term
3. The number of advance rentals or security deposits
4. Purchase option or purchase requirement
5. Documentation fees
6. Filing fees
7. Application fees
8. Inspection fees
9. Personal guarantors
10. Contingencies
11. Conditions
12. When your approval commitment expires
13. When your rate commitment expires
14. Condition for return of any deposits or advance rentals

Your leasing company should have no objection to providing you with this sort of written approval. If they will not give you this willingly, be careful.

Do you require a deposit before you formally approve my credit AND the terms that I have requested? If so, is that deposit refundable? Under what conditions would my deposit not be refundable?
Many leasing companies will require a deposit before they issue a formal approval. Typically this is used to insure that the lessee is serious about doing a lease before the leasing company spends its resources issuing a commitment. If the transaction is approved and has funded within the specified period, the entire deposit should be applied to the lease advance rental requirements. If the transaction is not approved within a reasonable period of time, usually specified, the fee should be fully refundable. If you are not able to receive both of these conditions in writing - watch out!

What is the exact amount of the monthly rental?
Make certain what is included in your monthly payment. Some companies will quote you a lease payment based on the total equipment cost including sales tax but may try to add sales or use tax to your payment again. A use tax is a monthly charge for the use of the equipment and is never charged in addition to sales tax.

What is the exact equipment acquisition cost used to determine this rental?
The exact equipment acquisition cost may include tax, shipping, training, warranties and other soft costs. You should know what is included in your lease and exactly what the leasing company is willing to pay. Any costs that are excluded will be your responsibility to pay.

What is the lease factor?
The lease factor is a mathematical expression of your lease payment as a percent of the equipment acquisition cost. In plain English this means the lease factor is the percent of the equipment cost you are paying each month to lease the equipment. A lease factor of .0330 (representing a 36 month lease) means that you are paying the leasing company 3.3% of that cost per month for 36 months or (3.3 X 36) 118%. Please note that the 118% consists of two components, exactly 100% is the equipment cost and 18% is the lease finance charge for the three-year period.

How many Advance Rentals are required for this Lease? Are they applied as rental payments or are they applied as Security Deposits? If they are Security Deposits are they refundable and when?
Some companies will apply Advance Rentals as Security Deposits. This has a positive effect on their yield and may have a negative effect on your rate. Furthermore, you may be required to make all rentals (remember, deposits are not rentals) and then request a refund in writing. If you do not comply with the refund requirements you may forfeit these deposits. Ask first and then check the face of the Lease Agreement.

What fees or other costs are we required to pay and how much are they?
Typically leasing companies charge a documentation fee and may charge a filing fee in special situations. These fees may range from hundreds of dollars to thousands of dollars. These fees are used to greatly enhance lease yield.

What is my Purchase Option in dollars? What is it as a percentage of the equipment cost?
GET YOUR OPTION IN WRITING. Insist that it specify exactly how much the option is and what assets it pertains to. It should include all assets under lease.

Exactly what must I do to exercise my Purchase Option?
GET YOUR OPTION IN WRITING Insist that all terms and conditions required for you to exercise that option are identified in a separate letter in addition to the boiler plate language of the Lease Agreement.

Is there an Automatic Renewal clause in the Lease? If so, what is the renewal term and what conditions trigger it?
Some Lease Agreements contain Automatic Renewal clauses. These are generally obscure clauses in your agreement which require the lessee to notify the lessor of some decision, usually their election to exercise their Purchase Option at a very specific point during the lease term. If the lessee fails to comply with the requirement timely the lease term is automatically renewed for a specified period of time. BEWARE if the renewal period is greater than month to month. In some cases the renewal period may be a year, therefore, you will be responsible to make twelve additional lease payments.

How do you handle complaints from your customers?
No matter how well intended a company is, you simply will not please everybody all the time. The method in which customer complaints are handled may tell you a great deal about the company you will be dealing with for the next few years. This is a good indication if the company is interested in your relationship or just your business. A good place to check is the local Better Business Bureau.

Remember!
It was recently reported that there are over two thousand leasing companies in the United States. Most of these companies are owned and operated by good people and provide a legitimate and professional service. Asking the questions detailed in this section will increase your chances of dealing with one of them and decrease your chances of being taken advantage of.

Selecting a broker or financial intermediary
The decision as to which leasing company you work with can be an extremely important one. Perhaps it is as important as your choice of which attorney, accountant, financial planner or insurance agent you rely on. You should chose a company that is willing to understand and accomplish your financial and strategic objectives and has the capabilities to provide you with information about and access to the most current and competitive financial solutions available.

The key to success is to select a company you are comfortable with. If all goes well, your leasing company will be with you for a long time, so the choice is an important one. If all doesn't go right the wrong choice can be very expensive (see Leasing Horror Story). Pricing is always a factor, but the relationship and therefore trust should be your primary considerations.

If you have any questions or would like additional information, please feel free to contact This e-mail address is being protected from spambots. You need JavaScript enabled to view it at (800) 836-7753 ext. 401.

Got a question?
With our extensive experience in leasing and financing, we can answer any finance-related question you may have. Feel free to give us a call or Ask The Lease Doctor!