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If you plan to keep equipment beyond term of lease, it is generally cheaper to enter into a bargain purchase/capital lease. During lease, you pay lessor a rate of return plus cost of equipment. At end of lease, you receive equipment title for a nominal payment. If equipment is subject to rapid obsolescence or if you feel confident that you will return equipment at end of lease, a FMV or operating lease might prove advantageous. What you are getting in a FMV or operating lease is flexibility to kick equipment out at lease end. Additionally, this form of lease can lower your lease rate as lessor passes a portion of anticipated residual value back to your firm in form of lower payments. If your firm has reason to minimize liabilities appearing on balance sheet, perhaps due to bank financial covenants, an operating lease might be appealing. In these lease situations, balance sheet concerns may trump desire to obtain lowest lease rate. In choosing a lease form, look at period of intended equipment use, potential for equipment obsolescence, balance sheet considerations, income tax considerations and any other factors that might influence lease choice.
Failing to Evaluate Vendor Service - Equipment Lease Arrangements
Entering into a ‘hell or high water’ equipment lease involving proprietary equipment required for a multi-year service (such as alternative energy or telephone services) can lead your firm into a situation ripe for blunder. Even under best of circumstances, a ‘hell or high water’ equipment lease (one requiring non-cancelable payments) entered into in connection with a service arrangement carries a certain degree of risk. In many cases, lease is provided by a leasing company independent from service provider or later sold by service provider to a lessor. The potential pitfall results from possibility that your company might get stuck making lease payments for equipment it can no longer use, should service provider fail or cease to offer service. The best protection against this potential pitfall is to avoid these types of arrangements. If you must enter into such an arrangement, make sure service provider is financially sound, reputable, and has a long track record of providing excellent service. Also, since these transactions always carry some risk, make sure that an abrupt interruption in service will not have a material negative impact on your company or cause financial hardship.
Ignoring End-of-lease Notice Deadline
While not a deadly blunder, failing to give timely notice at end of your lease can create significant additional lease expense for your firm if you plan to return equipment. Many leases have provisions that require lessee to notify lessor of lessee’s decision to return equipment at end of lease. If you violate notice period, lease kicks into an often unfavorable automatic renewal period, usually one to six months. If you intend to return equipment at lease end, make sure your firm gives notice on time. It can save your firm a bundle in avoidable lease expense.
Underestimating Time Required to Close Lease
Not allowing enough time to go through lease planning, proposal, approval and documentation phases can result in extra cost. A rushed process can lead to poor lessor selection, approval delays, documentation miscues or poorly negotiated lease terms. Except in small ticket transactions (under $ 75,000 to $ 100,000) where personal guarantees of principals are involved, most lease transactions take at least three weeks or more to close. While some of time is consumed in bidding and credit review processes, much of it can be eaten up by administrative matters. Obtaining insurance certificates, filing UCC financing statements, reviewing and negotiating lease agreement, all contribute to time it takes to get to a lease closing. The best way to manage lease closing process and to save precious time and money is to plan ahead. Make sure you establish criteria for lease you are seeking, prepare a package containing information all bidders would want, obtain a lease closing list from each lease bidder, and respond to all requests/questions raised by bidding lessors on a timely basis.
While equipment leasing pitfalls can not always be avoided, you can take steps to prevent snags that can cost your firm a mint. Plan ahead and do your homework before launching lease bidding process. Give high priority to selecting an experienced lease provider with high integrity and good expertise. Also, with lease transactions that represent significant obligations for your firm, engage a competent attorney to help you review and negotiate equipment lease.
George Parker is a Director and Executive Vice President of Leasing Technologies International, Inc. (“LTI”). Headquartered in Wilton, CT, LTI is a leasing firm specializing nationally in equipment financing programs for emerging growth and later-stage, venture capital backed companies. More information about LTI is available at: www.ltileasing.com.