The ABCs of Leasing

One of the surgeons at your facility is clamoring for a new piece of equipment-the latest and greatest technology, he says-with the newfangled oscillating X-ray argon laser, he'll be able to at least double his caseload in less than a month. You're convinced, and so is your medical board-problem is, your cash flow has been a little sluggish and you're almost maxed out at the bank. Where to turn?

You may want to consider leasing. The decisions about whether to lease, what kind of lease is best, whom to lease from and how to make sure the lease agreement is fair can be fairly involved. Here's advice that may help you wade through the complexities.

Pros and Cons of Leasing

Leasing has several advantages, says Richard Contino, author of Handbook of Equipment Leasing: A Deal Maker's Guide.

Minimizes obsolescence concerns: If you need to acquire a piece of equipment that is likely to become obsolete or wear out before you finish purchasing it, leasing may make sense, says Mr. Contino. This may apply to items where the technology is changing rapidly, such as excimer lasers, or items that incur a lot of wear and tear, such as flexible endoscopes. It makes less sense to lease items in which the technology is unlikely to progress quickly or items that will last longer, such as tables, lights, and anesthesia machines.

Procures equipment for a limited use or trial basis: Leasing can provide a way for surgery centers to offer a new service without laying out a lot of cash. This is the route that Abington Surgical Center in Willow Grove, Pa., is taking to start offering endoscopy, according to Stan Grissinger, Executive Director. After a GI surgeon expressed interest in doing the procedures, the center negotiated with an endoscope maker to provide all the equipment, plus routine maintenance. "We will pay on a cost-per-procedure basis. This way, we get to offer endoscopy, don't have to put a penny down, and can categorize the cost as an operating expense" says Mr. Grissinger.

Preserves capital, increases cash flow, and provides a hedge against inflation: "The bottom line advantage to leasing is that, if you negotiate right, and if you are a responsible credit risk, you don't lay out any money up front," says Mr. Contino. "People get focused on the interest rate charges, but you really have to take a hard look at how you can best put the money to use."

Mr. Contino also points out that leasing equipment gives you the ability to acquire equipment you need at today's prices and pay for it with tomorrow's earnings. In other words, leasing is a hedge against inflation.

Reduces taxable income: Some types of leases enable you to immediately write off payments as operating expenses. These payments are tax-deductible, meaning you can deduct the cost of the payment from your corporate income in the year in which you made it.

May preserve your borrowing power: In the past, one big advantage to leasing was that certain lease payments didn't show up on your balance sheet as long-term liability, making an organization seem like a better credit risk to other prospective lenders. However, many banks have wised up to this tactic, says Mr. Contino. "Regardless of whether a company records lease obligations on the balance sheet, many lenders factor them into their evaluation of a company's financial condition." This is not always the case, however-in certain instances, you may be able to structure a long-term lease "off the balance sheet."

May be more feasible than a loan: Taking out a loan is another option if you don't have ready cash, and if your financial position is strong, a bank may be able to give you a lower interest rate than a leasing company. However, leasing companies are much more likely than banks to be flexible in their payment terms; many will extend credit in a short time and allow you to skip payments, for example.

The disadvantages of leasing are fairly simple. First, you could end up paying a higher interest rate to lease. Depending on several factors, you may end up paying from a fraction of a percentage point more in interest to as many as six or seven points more. (Be careful to analyze this carefully and compare "apples to apples." Some leasing companies use confusing terminology that tends to fog the issue). Second, at the end of the leasing period you must either turn the equipment in or buy it, typically at fair market value.

Leases come in two different flavors. A brief description of each: A full payout lease (sometimes referred to as a long-term, financial or capital lease) is the most traditional type of lease. It typically has a longer term that covers a larger portion of the useful life of the equipment. The rental payments and interest rates tend to be relatively low, and the lease payments are spread out over a longer period.

Full payout leases allow you to purchase the equipment at the end of the lease term. The two options are usually a "$1 buyout," where the lessee may purchase the equipment for a dollar, or a "put lease," where the lessee must purchase the equipment for some predetermined percentage of the original invoice price. When one of these options exists, these leases are referred to as conditional sale-type leases by the IRS. Another way to buy the equipment is to agree upfront to pay a percentage of the invoice price at the end of the term.

A short-term lease (sometimes referred to as an operating lease) has a term that is much shorter than the expected useful life of the equipment. It's generally used for high-tech equipment and may work best for facilities that want to always have the "latest and greatest" instrumentation and equipment. At the end of the lease term, the lessor typically re-leases or sells the item.

Operating leases generally are better tax-wise than capital leases in the form of a conditional sale, since you can deduct the full amount of your lease payments from your tax bill in the year you made them. When a capital lease is, in effect, a conditional sale, you can deduct only the interest portion. You can, however, claim depreciation on the asset's cost.

Be flexible when deciding between short-term and long-term leases, Mr. Contino recommends. In general, it may be a good idea to choose short-term leases for equipment that will soon reach obsolescence, but that's not always the case. "Sometimes, you may think you're going to replace something in five years, but at the end of the lease, the new system that you planned to get isn't even out yet," he says.

Who Leases Equipment

You can typically obtain a lease from the vendor you're purchasing the equipment from or from an independent leasing company. If you lease through the vendor, the company may be willing to make concessions to get the deal. Some vendors also agree to maintain the equipment. But in other cases an independent leasing company may offer the best deal, in terms of payment flexibility and low interest rates. Generally, a vendor will offer financing through its own leasing company, or a partner company. The two companies may work together to form a deal that's in their best interests, perhaps passing on a lot of hidden costs to the lessee.

Mr. Contino recommends keeping the negotiations for the purchase price of the equipment and the financing completely separate. Once you're ready to think about financing, get quotes on leasing options from your vendor, as well as at least two other leasing companies to make sure you're getting the best deal, he says.

Evaluating a Lease Agreement

The Equipment Leasing Association, which provides information and education about leasing and the leasing industry, recommends asking the following questions when deciding whether to lease or evaluating a lease agreement:
1. How am I planning to use this equipment?
2. Does the leasing rep understand my business?
3. What is the total lease payment and are there any other costs that I could incur before the lease ends?
4. What happens if I want to change this lease or end it early?
5. How am I responsible if the equipment is damaged or destroyed?
6. What are my obligations for the equipment (such as insurance, taxes and maintenance) during the lease?
7. Can I upgrade the equipment or add equipment under this lease?
8. What are my options at the end of the lease?
9. What are the procedures I must follow if I choose to return the equipment?
10. Are there any extra costs at the end of the lease?