One of the central decisions a financial manager must make when acquiring business equipment is whether to lease the equipment or buy it.
To make the best decision, I recommend you focus on these basic questions as part of your planning process:
- What are you acquiring?
- Why are you acquiring it?
- When should you lease or use equipment financing?
What are you acquiring?
Before determining what equipment financing structures are available, you do some capital expenditure planning. Start by identifying assets you need to replace or acquire. Not all assets can be leased. Some assets that are typically financed include:
- Limited-use assets. You can't lease custom-developed equipment that can only be used by your business. If you don't make your lease payments, your lessor will need to sell or lease the equipment to someone else. But limited use assets, such as custom-built equipment, often have no secondary market.
- Software. This is another type of asset a lessor would have issues leasing. Most software lease transactions are structured as conditional sales or $1 buyout leases - in other words, they're loans disguised as leases.
- Assets with high ownership liability. Lessors have different risk tolerances, but there are certain asset types most will view as bad risks; either they won't allow clients to lease them or they will charge a premium to do so. One example is a fleet of school buses. Lessors know a school bus accident could lead to litigation targeting them as the bus owner, in addition to the lessee. Before you consider whether you should lease or buy equipment as part of your capex plan, determine if leasing is even an option.
Why are you acquiring it?
The lease versus buy decision will also be impacted by your reason for acquiring the equipment. Most capital expenditures fall into one of three categories:
- Maintenance capex: core equipment you need to maintain the current operations of your business.
- Growth capex: equipment you would need if you landed your next big account.
- Speculative capex: equipment you acquire with the hope that it will enable you to land future business.
When should you lease versus finance?
Once you know the purpose of the equipment you will be acquiring, you can start sorting through whether it will make more sense to finance or lease.
Financing typically makes more sense when acquiring core equipment you plan to keep for all of its useful life, and you can use the depreciation. If you lease, you run the risk of needing the equipment after the lease agreement has expired, requiring you to essentially acquire the equipment a second time.
The decision-making process in this article is fairly straightforward. However, there are many variables and financing options to consider. At Hancock Whitney, we can suggest alternatives for you to select from in consultation with your tax professionals.
For more information, visit www.hancockwhitney.com or call (504) 299-5097.
