Leasing vs. Buying Small Business Equipment
When it comes to leasing or buying small business equipment, there’s plenty of benefits and drawbacks on both sides. Leasing is ultimately more expensive, but buying requires significant upfront costs. So which to choose? Entrepreneur explores the issue of leasing vs. buying. Below, we break down the pros and cons, as well as some questions to help you determine the right fit.
Leasing: The Benefits
- Leasing keeps your equipment up-to-date. Computers and other tech equipment eventually become obsolete. With a lease, you pass the financial burden of obsolescence to the equipment leasing company. For example, let’s say you have a two-year lease on a copy machine. After that lease expires, you’re free to lease whatever equipment is newer, faster and cheaper. (This is also a reason some people prefer to lease their cars.) In fact, 65 percent of respondents to a 2005 Equipment Leasing Association survey said the ability to have the latest equipment was leasing’s number-one perceived benefit.
- You’ll have predictable monthly expenses. With a lease, you have a pre-determined monthly line item, which can help you budget more effectively. Thirty-five percent of respondents to the Equipment Leasing Association’s survey said this was leasing’s second-highest benefit.
- You pay nothing up front. Many small businesses struggle with cash flow and must keep their coffers as full as possible. Because leases rarely require a down payment, you can acquire new equipment without tapping much-needed funds.
- You’re able to more easily keep up with your competitors. Leasing can enable your small business to acquire sophisticated technology, such as a voice over internet protocol (VoIP) phone system, that might be otherwise unaffordable. The result: You’re better able to keep up with your larger competitors without draining your financial resources.
Leasing: The Downsides
- You’ll pay more in the long run. Ultimately, leasing is almost always more expensive than purchasing. For example, a $4,000 computer would cost a total of $5,760 if leased for three years at $160 per month but only $4,000 (plus sales tax) if purchased outright.
- You’re obligated to keep paying even if you stop using the equipment. Depending on the lease terms, you may have to make payments for the entire lease period, even if you no longer need the equipment, which can happen if your business changes.
Buying: The Benefits
- It’s easier than leasing. Buying equipment is easy–you decide what you need, then go out and buy it. Taking out a lease, however, involves at least some paperwork, as leasing companies often ask for detailed, updated financial information. They may also ask how and where the leased equipment will be used. Also, lease terms can be complicated to negotiate. And if you don’t negotiate properly, you could end up paying more than you should or receiving unfavorable terms.
- You call the shots regarding maintenance. Equipment leases often require you to maintain equipment according to the leasing company’s specifications, and that can get expensive. When you buy the equipment outright, you determine the maintenance schedule yourself.
- Your equipment is deductible. Section 179 of the IRS code lets you deduct the full cost of newly purchased assets, such as computer equipment, in the first year. With most leases favored by small businesses–called operating leases–you can only deduct the monthly payment.
Buying: The Downsides
- The initial outlay for needed equipment may be too much. Your business may have to tie up lines of credit or cough up a hefty sum to acquire the equipment it needs. Those lines of credit and funds could be used elsewhere for marketing, advertising or other functions that can help grow your business.
- Eventually, you’re stuck with outdated equipment. As I mentioned earlier, computer technology becomes outdated quickly. A growing small business may need to refresh its technology in some areas every 18 months. That means you’re eventually stuck with outdated equipment that you must donate, sell or recycle.
Asking the Right Questions
If you’re thinking about leasing equipment, you’ll need to do your homework to ensure you get the most favorable terms. Here are a few questions that’ll help you get started:
What type of lease are you being asked to sign–a capital lease or an operating lease?
A capital lease is similar to a loan. With this type of lease, the equipment is considered an asset on your balance sheet, and you get the benefits–such as tax depreciation–and risks–including obsolescence–of ownership. Capital leases are often for as long as five years.
With an operating lease , the leasing company retains ownership, and for tax purposes, the equipment is considered a monthly operating expense rather than a depreciable asset. Operating leases are generally more popular among small businesses because they don’t tie up funds and are usually short-term–three years or less.
Is there a buyout option?
You may have a choice between a fair-market value (FMV) option and a $1 buyout option. FMV means you can buy the equipment at the lease’s end for its fair-market value, which could be hundreds of dollars. In contrast, a $1 buyout option means the equipment is yours for $1 when the lease expires. And while that sounds like the best option, keep in mind that monthly payments on FMV leases are usually lower than $1 buyout leases. If you’re fairly certain you’ll want to upgrade to new technology when your lease expires, go with the FMV option.
How long is the lease for?
Usually, leases for computer equipment run 24, 36 or 48 months. The longer your lease, the lower your monthly payments–but you’re also likely to pay more over time with a longer lease.
Does the equipment have to be insured?
Some leasing companies require you to insure the leased equipment. If you don’t, fees may be added to your monthly payment to cover insurance.
Can I add to the lease?
Most leasing companies don’t mind if you add equipment to an existing lease. Your lease payment will be recalculated accordingly; lease terms don’t usually change.
Can I terminate the lease early?
What if you no longer need the equipment you’re leasing or you want to upgrade to newer technology sooner than you expected? Find out in advance if you can pay off your lease early, and if there’s a prepayment penalty (and if so, how much?).
The Great Debate: Lease or Buy?
Clearly, there are reasons to choose either option. If you ultimately want to save money, but sacrifice some flexibility, choose buying. If you’d rather have the most advanced technology and some flexibility with the equipment you use, at a higher cost, then leasing is right for you. Review what is needed out of your business equipment before deciding.