What Entrepreneurs Should Know
About Equipment Leasing

By Nina L. Kaufman, Esq

Cash flow challenges present a dilemma that many entrepreneurs face. You need to grow, but lack the available cash to invest in the growth. For example, you may need a computer network, or telephone system, and the sticker price sends you into an anaphylactic shock. What's a business owner to do?

Thankfully, for some, there is an option in the form of equipment leases. An equipment lease is a form of loan where the equipment owner (the "lender") rents the equipment to a business at a flat monthly rate for a specified number of months. At the end the lease, the business may purchase the equipment for its fair market value (or a fixed or predetermined amount), continue leasing the old equipment, lease new equipment, or return the old equipment. An advantage to equipment leases is that they can be easier to obtain (and with less formality) than a bank loan to buy the equipment outright. The disadvantage: lease financing tends to be more expensive (in terms of the interest charged on the lease) than bank financing.

Lex AppealHow do you know when it's right to lease? As a guideline, "buy - don't lease -- anything small enough to set on your desk or that costs under $3,000," suggests Arleen Kahn, President of AMK Associates, a cost-management firm based in New York City. "Because in most of those situations, the replacement cost of the equipment may not be worth the interest expense of a lease," she adds.

When the time is right to lease, Kahn points appreciatively to the flexibility it can provide a business, not the least of which include the convenience of the relatively simple credit applications, 100% financing options, the preservation of working capital, and avoiding the risk of equipment obsolescence.
But leasing is not without its traps for the unwary. Kahn cautions business owners to look carefully when presented with the following lease provisions:

  • Lease Term. Leases exist for only a finite length of time. Kahn cautions entrepreneurs to avoid leases that extend longer than 3 years/36 months. "Equipment can become obsolete within two years, and you don't want to be stuck with a dinosaur that n one wants to service any more," she says. Also, the needs of your company could change radically (for either good or ill) during that time, in which case you don't want to be stuck with lease terms that are no longer suit you.

  • Equipment Insurance. Watch this little line item carefully. Sometimes it won't even show up as "insurance" (it may be given a deceptively vague and fancy name, like "ValueMax"). Don't let the cute name deter you: it's insurance. Most, if not all, equipment leases include it. But the bottom line is that you don't need it if your company's general liability insurance would cover it (in essence, you're paying double for the insurance on the equipment!). You can negotiate to have this cost removed if you provide the equipment lessor with a valid certificate of insurance in acceptable coverage amounts.

  • Service/Maintenance Contracts: According to Kahn, "That's where dealers really make their money; not so much on the lease itself." She advises companies to consider their maintenance needs carefully. "Do you really need an ongoing service contract? Will you really use it all the time?" she asks. "It might be more cost-efficient to pay for time and materials than to add thousands of dollars to your operating expenses for service contracts." In addition, as Kahn points out, "There's a 90-day warranty on the equipment. So why do you need a service plan to start on Day 1? It could technically waive your 90-day warranty! Get the service plan to start on Day 91 instead," she suggests.

  • Automatic Renewal: Every once in a while, an automatic renewal provision crops up in a lease. These provide that the lease will automatically renew for the same length of time as the original lease unless you, the business owner, notify the lessor that you do not wish to renew the lease. Look for them carefully and check with your attorney to see whether they're valid. "In [some states like] New York, these kinds of terms are prohibited by law," said Kahn. "And they're prohibited for a very common sense reason: they're an unfair financial burden upon business owners. If the equipment lease is going to renew, you must be provided with written notice in advance."

Equipment leases can provide a quick solution to a business growth challenge. Make sure that you understand the terms of any lease - the risks and the obligations - before you sign. And don't forget to speak to an attorney and a cost-management consultant - they can help identify the lease terms you may want to negotiate!

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© 2004-2009 The Legal Edge LLC.  Want to save time, money, and aggravation with pesky business law issues? Award-winning business lawyer and Entrepreneur Magazine online columnist/blogger Nina Kaufman has user-friendly business law resources for entrepreneurs that demystify legalese. Get your free copy of her Entrepreneurs Business Law Primer from GreatBusinessLawResources.com today!

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