
	What is Leasing?

What is Leasing?

Since we have received so many questions from our clients about leasing, and since we could not find a leasing company who provides answers to these questions, we decided to publish this document that we gleaned from various sources. "What is Leasing?" is for your information only, and....

WE MAKE NO REPRESENTATION AS TO THE ACCURACY OR VALIDITY OF ANY AND ALL OF THE INFORMATION CONTAINED HEREIN, AND PRESENT SAME FOR OVERVIEW PURPOSES ONLY. IF ANYTHING CONTAINED HEREIN IS TO BE USED FOR ANY SPECIFIC PURPOSE, COMPETENT EXPERTS SHOULD BE SOUGHT FOR CONFIRMATION OF THE INFORMATION AND GUIDANCE IN ITS USE.

There are various books on the market that explains leasing in more detail, which you can obtain from your library. There is also reference material available on the Internet.

What is leasing?

For most businesses, the ability to use information systems (or any equipment) is far more important than the need to own it. Leasing provides unrestricted use of information systems that can be paid for as the system produces results.

With leasing you obtain the information system that you need now and in the future, without straining your budget or cash flow. Since the cost can be spread over several years, information systems can be acquired or upgraded more often, without straining budgets.

A lease is a transaction wherein a "Lessor" owns particular equipment and agrees to permit a "Lessee" to use it. Lease terms typically cover one to eight or more year periods, depending upon the specific equipment's type and usage. Lessors ordinarily offer monthly, quarterly, semi-annual, or annual payment scheduling, where applicable. Individualized payment structures can often be tailored to meet particular lessee's accounting, cash flow, or other financial requirements. Lease Agreements can often provide for the Lessee's purchase of the equipment at the end of the original lease term. Most often, the Lessee will select the specific equipment to be leased and choose the vendor from whom that equipment will be purchased. The Lessor will then purchase the equipment on the Lessee's behalf.

Remember. All leasing companies are not created equal.

What are the benefits of leasing information systems?

Leasing offers the following benefits:

	Profits come from use, rather than ownership of equipment. Lease new or improved equipment to increase your working capital position. Working capital should be used for operations or expansion, i.e., payroll, inventory, sales expansion or for profitable investment in new product development. In effect, you increase your capital without expanding your capitalization.
	Leasing provides 100% financing for equipment acquisitions.
	Leasing does not affect your bank lines of credit, rather you obtain an additional line of credit for equipment purchases which is not shown on your balance sheet.
	Your cash flow is improved. Leasing does not require down payments, rather you normally pay 2-3 advance monthly payments.
	Leasing helps to overcome budget restrictions and limitations.
	Leasing may provide tax savings.
	Leasing acts as a hedge against inflation. By taking advantage of long term financing, you are paying with "cheaper dollars" due over an extended future period.
	You chose the specific information system to satisfy your needs, from the supplier of your choice.
	You protect your business against operating obsolete equipment.

Can I lease software only?

The computer hardware industry has grown exponentially since the 1950's - and so did the computer hardware leasing industry. In fact, leasing was probably the biggest contributing factor to the growth of the computer hardware industry.

In 1994, information technology expenditures were split evenly between hardware and software/services. Yet, business owners never consider leasing software only, because software is intangible. However, an intangible can have value - like a book or a movie - and it can have a useful life (like a Mozart symphony or an opera or a word processing or database program).

Software leasing is just about the same as equipment leasing, except it's for an intangible - the software and the software license. It is a method of paying for software over time instead of a single up-front payment and the functional equivalent of a loan from the leasing company or the software developer. It is normally structured as a capital lease rather than an operating lease. However, it is often accounted for as an operating lease.

Some benefits to you:

	Include consulting, hardware, customization, and training costs in the lease. Bundling the individual components of a project in one lease is normally simpler and tends to level your expenses as you realize benefits from the software.
	Include internal implementation costs and/or external professional fees (i.e., CPA or lawyer) in the lease where appropriate. Include your costs for data conversion, training, lawyer's review of the agreements, CPA's fees for ascertaining internal controls, and other such information system-related costs.
	You can own the license at the end of the lease without additional payment. In fact, unless you clearly have only a short-term need for the software, you should only execute a finance lease where there are no additional payments at the end of the lease. Thus, an operating lease with an option to purchase at fair market value option at the end of the lease will in almost all cases turn out to an expensive proposition.
	Correct the failure of many accounting systems to recognize the long-term benefits of software and related costs. A lease will in most cases permit you to better match software expenses with the period of benefit.
	Obtain all the licenses that are needed now to supply all users. You have funds allocated in your budget for only some of the licenses you need. You can arrange a lease for all the licenses you need and still be within your annual budget requirements.

What criteria is used for a software-only lease?

As with any lease, the most important factor is the strength of your business. If you have a good relationship with a leasing company or with your bank, who may also have a leasing department, you may be able to get a software lease.

Typically, the software lease must be greater than $25,000 and the lease term is not more than 36 months.

What are the different types of leases?

For most businesses, there are three types of leases to consider:

1. True Lease:

True Leases do not call for full pay-out of the equipment cost and financing charge during the term of the lease. Typically, the lessee does not have an option to purchase the equipment at the end of the lease, or, at most, you have a Fair Market Value option. Such an agreement is recognized by the Internal Revenue Service as a rental agreement. Hence, the monthly lease payments are classified as operating expenses, and qualify as fully tax deductible expenses. True leases are not capitalized on the user's financial statements, eliminating impacts on the company's stated financial condition.

2. Fair Market Value (FMV) Lease:

The Fair Market Value (FMV) Lease is generally the most popular lease. It is beneficial for businesses needing the cash flow advantages of low monthly payments. It provides several end-of-lease options to customers that help maintain the relationship with the vendor:

Trade-up to a new lease

Continue month-to-month leasing

Return the equipment

Re-lease the equipment at its fair rental value

Purchase the equipment at fair market value

As stated in True Lease above, FMV Lease can be tax deductible. FMV is determined at lease expiration by recognized appraisers or similar experts in the specific equipment.

3. Lease Purchase/Finance Lease/Capital Lease/$1 Buyout:

These four terms are used to describe the same lease type. You have the advantages of leasing including fixed monthly payments, with the guaranteed option to purchase the equipment at the end of the lease term for a predetermined amount, usually one dollar. This type of lease provides the lessee with a fixed purchase option when the lease is executed. In many cases, it eliminates uncertainty over what the Fair Market Value of the equipment may be at the end of the lease.

Since the end-of-term purchase price is predetermined, this lease type may not meet the requirements for tax deductibility or for accounting for the lease off the Balance Sheet.

What is needed to obtain a lease?

You complete a lease application (see sample attached), which is very similar to a credit application. It asks for specific information about the business, like:

	Legal name of the business
	Type business (Corporation, partnership, proprietorship)
	State of incorporation
	Length of time in business
	Nature of business
	Principals information, i.e., name, home address, social security number.
	Bank reference
	Trade references
	Equipment supplier information and detailed equipment list

Once a leasing company receives your application, they will contact your bank, trade references and independent credit bureaus to determine whether or not they will accept the lease. Their decision making is generally aided by a "Credit Scoring" system, and financial statements may not be required at this point.

Credit Scoring models are generally derived from the particular leasing company's historical portfolio performance with lessee's of similar type, organizational structure, credit history, size, age, and credit bureau rating, along with such other criteria as individual leasing companies choose to include. Scoring criteria vary, predicated on transaction size, type of business, and the leasing company's particular preferences. Often, if one leasing company rejects your lease, another may take it, as they have different criteria. Financial information requirements and credit criteria are established by each leasing company at their own discretion.

Depending on the lease amount and the leasing company, you may need accountant's prepared financial statements or federal income tax returns - usually for the last two years plus an interim statement (prepared internally).

If your business is a corporation, you may need a "Corporate Resolution" whereby the Corporate Secretary or other authorized officer attests that the signatory is empowered, by name or title, to execute lease agreements. As a rule, the requirement of a Corporate Resolution depends on the equipment cost, type of lease, and the particular policies of individual lessors. Most leasing transactions covering equipment costing less than $25,000 do not require this document. The leasing company usually provides such documents for signature. You will also need an invoice from your vendor that "sells" the system to the leasing company and ships it to you.

Once approved, the leasing company will issue a purchase order to the vendor. Your payments begin when you have accepted the system (see "How does the vendor get paid"). Your initial payments are normally the first and last (or last two) monthly lease payments.

How much of a down payment do I need?

Leases do not require down payments. Conditional sales contracts or bank loans, and other types of equipment-based financing frequently require the borrower to pay 10 to 25 percent of the purchase price at the outset. Once the lease is approved, you normally pay the first and last (or last two) monthly lease payments.

Sometimes a creative leasing company may approve your lease with a "Prepaid Lease Option" whereby you pre-pay the purchase option at the lease inception. It is an ideal way for companies with a poor credit history or a new company to obtain a lease.

Do I have to personally guarantee the lease?

Guarantees depend on a number of factors - type of business, length of time in business, size of company, credit worthiness, and other such factors. In some instances, leasing companies as a matter of practice request a personal guaranty, which you then negotiate with them. Frequently business owners of proprietorships, partnerships, closely-held corporations, or small businesses may be required to personally guarantee a leasing transaction.

At other times, a business may be a subsidiary of, or owned wholly or in part by, another business. Depending on the circumstances, the Lessee's "Parent"' may be required to guarantee a lease.

Do I need insurance?

Most Lessors require the Lessee to insure the equipment against casualty loss, all risks, and require that the Lessee indemnify the Lessor against any liability incurred from the possession, operation, or usage of the equipment.

How do I calculate the lease payment and the interest?

Lease Agreements usually call for a fixed payment amount for a fixed period of time. To simplify leasing payment calculation, leasing rates are typically stated as the number of dollars charged per thousand dollars of equipment cost leased, per specific period of time. The percentage of equipment cost leased per period of time is commonly known as a "Rate Factor". Once the appropriate Rate Factor has been calculated, any applicable equipment cost can then be multiplied by that Rate Factor to derive the lease payment.

For example, let us assume you are leasing an information system for $50,000 and you are given a rate factor of .02214 for a 60 month lease. This means the leasing charge is $24.14 per $1,000 per month. To calculate your monthly payment multiply $50,000 X .02214 to obtain your monthly payment of $1,107.

Leasing Rate Factors are based on various criteria such as:

	The current cost of money (Money Market costs)
	Lease term
	Equipment cost
	Purchase option alternatives
	Lease type and structure
	Residual value of the equipment

... and any other variables applicable to particular lease configurations.

You will also be required to pay any applicable taxes or fees related to the leased equipment including sales or use tax, personal property tax, or any other such taxes of any kind. These taxes apply where the system resides, not from where it was purchased. If, for example, your business is in a state with 8% sales tax and part of the system will reside in a state with 6% sales tax, then the amount applicable to each state will be taxed accordingly.

Since a lease is not a loan, you normally do not obtain the interest charged on the lease. Suffice it to say that the interest on a lease will be higher than a loan, but the benefits far out way the extra expense (especially not tying up your credit line).

Are there flexible payment options?

This depends on the leasing company and their ability to structure a lease to meet your specific needs. Common lease structures include:

Step-Lease: Some Step-Leases call for lower payments early in the Lease term and higher payments later on. Businesses acquiring more costly or higher capacity equipment than currently needed, but who will require larger capacity in the future, find this plan attractive. Rather than installing a smaller system today, and then having to soon upgrade or replace the equipment, reduced front-end lease payments can permit the acquisition of higher capacity equipment at the Lease outset. Conversely, Step-Down leases can permit a faster write-off of leased equipment that will be obsolete in a short period of time. This structure matches the higher front-end leasing payments to the highest productivity stage of equipment usage.

Skip Payment Lease: This structure permits payment reductions or abatements during seasonal businesses' slow periods. Seasonal businesses can then match their lease payments to the times of year that a business generates its income.

No-Payment Lease: This lease structure offers a payment moratorium at lease inception. Ordinarily, the no-payment period is limited to two or three months, but, may sometimes extend as long as six months. Businesses benefit from No-Payment leases when new equipment requires a conversion, operator training, or set-up phase. This way, the Lessee is not required to remit lease payments during the equipment's initial start-up stage. No-Payment leases also help when existing equipment will be replaced shortly, but some leasing or financing payments remain. With a No-Payment period, Lessees can install new equipment earlier while avoiding making payments for both items. Often, installing new equipment while an older unit is still in place permits easier changeover and transfer to newer technology.

What happens if I default on the lease?

A leasing company will normally file a Uniform Commercial Code Financing Statement (UCC-1) with the Secretary of State's office, (and in some cases the County Clerk's office), in the State (and County, if applicable) where leased equipment is located. The purpose of filing these forms is to notify other parties who may seek a security or other interest in the specific equipment, that a particular Party currently has a secured interest in the identified equipment.

If you default on the lease, the leasing company can confiscate and sell the system. You are still responsible for the value of the lease (less the proceeds from the sale). You should review your lease to determine what ramifications are inherent in your default.

How does the vendor get paid?

The leasing company will issue a purchase order to the vendor authorizing purchase of the information system. If the vendor requires a deposit from you prior to accepting the order, your deposit will returned to you either by the leasing company or the vendor when you have accepted the system, and initiated the lease to begin.

When the leased system is delivered and installed, you typically authorize the leasing company, in writing, to pay for it. Your authorization to pay the vendor is indicated on an Equipment Acceptance Certificate form.

How do I find a good leasing company?

All leasing companies are not created equal, as all software vendors are not created equal. Your goal is to deal with a highly competent, professional firm who can provide superior service and has a high degree of integrity. Some specific points to consider:

Determine their level of experience with, and their "appetite" for your industry, your type of credit and with the computer industry. Some leasing companies will lease automobiles, but not computers. Others may lease hardware, but not software.

Get an understanding of the credit approval. When does the credit committee meet?
Who's on the committee? What types of deals are they currently investing in?

Does your rep have the pull within his own organization to get the deal done?

Determine if they are connected to your business in any other way? Example: Are they part of your banking syndicate? Supplier? Factor? Reason: You need to know if this will impact their willingness to lend.

How long will it take to get approval, and what information is needed. Have information about your company ready for them. This will speed up the credit review process. Example: Company fact sheet, 10K's, 10Q's, Annual Report, recent press releases and trade articles.

Your information system vendor should have leasing sources that they have worked with in the past. In some instances, they may use more than one leasing company, each of whom has different criteria - which can be tailored to each client's needs.

You should also contact your bank, factor and/or business associates who may have sources of leasing.

SUMMARY:

In our experience, leasing is a win-win situation. You obtain the information system that you need, when you need it, rather than having to wait until you have the capital to purchase. Your system is then able to assist you in making money, which offsets the cost of the lease.

If there are any questions, or if you need a leasing company, please do not hesitate to contact us.