IT Equipment Leasing
Independent of the size of organizations, how businesses handle the expense of IT hardware, software, and services is often a determining factor in when and whether they can acquire the new technology necessary to sustain business growth while improving productivity. For smaller organizations, an expenditure of $1 million for a server and storage upgrade may have to compete for the same budget that would fund a sales force expansion designed to increase revenue. Larger corporations may weigh the relative merits of a $20 million distribution expansion against a corporatewide IT infrastructure upgrade providing significant operational savings. Due to its inherent flexibility, leasing offers innovative ways to acquire IT equipment that can reduce much of the risk and uncertainty associated with new technology purchases and increase the leverage of the operating budget. Although the full payout lease and a traditional financing/payment model share similarities, the FMV lease offers end users some unique benefits beyond spreading out hardware payments. What are those potential benefits?
Conservation of capital.
A major benefit of leasing is that it allows a company to conserve capital for investment in its business rather than in the infrastructure required to run it. Unlike other methods of financing, leasing does not typically involve up-front commitment fees or require down payments or deposits. Additionally, many organizations are subject to regulatory requirements regarding the financial liquidity of a percentage of their asset base. In these cases, leasing allows a company’s assets to be invested in fluid financial instruments rather than in hard assets, which are typically difficult to convert and illiquid.
The majority of FMV technology leases are written in such a way as to qualify under approved accounting standards as operating leases. Although operating lease obligations are typically footnoted on a company’s balance sheet, the present value of the future rental stream is not included as a liability. Further, the leased equipment is not included as an asset. Due to the combination of these factors, in many instances a lease may have little or no impact on a company’s ability to borrow, and it could improve key financial measurements such as a company’s return on assets or debt-to-equity ratio.
Lessors provide payment flexibility tailored to the user’s specific cash flow or budgetary requirements. Frequency of payment may be monthly, quarterly, semiannually, or annually, with payment dates either in advance or arrears. Lessors can also provide payment and term flexibility tailored to match either project or revenue-generation milestones. Additionally, unlike a flat depreciation schedule or typical purchase financing, a lease can provide stepped payments, which either increase or decrease at specific times. An example of this payment flexibility would be financing a project that had a significant start-up period prior to revenue generation. The purchase of assets often requires payment on delivery, at installation, or within 30 days. As a result, a user may incur out-of-pocket expenses many months in advance of the productive use of the asset. With a lease, a user can defer the start of the payments until the equipment is fully operational . often for 90 to 180 days after installation. Further flexibility may be gained through a payment deferral option, which provides companies with the opportunity to delay payments for equipment until it can be put into a revenue-generating position. Although such deferrals will typically result in a higher lease rate, reflective of the costs of funds during the deferral period, they also allow companies to more closely manage expense recognition. In addition, some captive lessors may offer this option with the costs borne by their parent, not the lessee.
An FMV lease term can vary from a few months to four or more years, depending on the asset class involved. Corporations, however, depreciate most major new assets over five years, in contrast to shorter lease terms. By contrast, technology moves in two- to three-year cycles. Leasing provides the user with the opportunity to take advantage of technologies’ two- to three-year cycles of performance increases while paying for only the expected reduction in value during the term of the lease. Leasing enables the user to take advantage of the continually improving price/performance curve rather than being locked into equipment that might become obsolete before it is fully depreciated. Many organizations that routinely use leasing find that it provides a flexible, cost-efficient vehicle to fund new projects.
Leasing can provide additional flexibility when normal growth or new demands require the user to consider upgrading an asset. Where additional capacity or performance can be added directly to the original equipment, a lease can frequently be tailored to provide a predetermined periodic cost for the upgrade, based on the remaining finance term at the time of the upgrade. If physical replacement of the original asset is required, the lessor will often work with both the manufacturer and user to provide an optimum finance solution for the upgrade. Both of these upgrade scenarios can be addressed at lease inception, if the lessor is a finance arm of the manufacturer. Upgrade provisions can be negotiated that define upgrade costs in terms of cost per unit of capacity and performance. An example would be additional storage capacity financed for a guaranteed $/MB per month cost based on the timing of the upgrade.
When circumstances change and the lessee finds it advantageous to keep equipment longer than originally anticipated . either from a requirements or operational perspective . the lessee has the option to renew (often at a reduced rental rate) or purchase the equipment at the end of the lease at market prices. Conversely, lessors are always willing to entertain midterm upgrades or replacements, if business volumes justify this action. Companies also encounter situations in which equipment is required for a relatively short period of time (6.24 months) and leasing may be the only economically viable way to acquire the equipment. Examples include situations in which a user needs equipment to fulfill proof-of-concept requirements, interim equipment prior to a major new deployment, or temporary equipment necessitated by a natural disaster. In such cases, the lessee is best served by utilizing a lessor with remarketing expertise in the class of assets required. An economically attractive short-term lease is a direct result of the lessor’s ability to capitalize on the accuracy of the projected value at the end of the lease.
Residual value risk.
Leasing transfers the risk of obsolescence to the lessor while allowing the lessee to benefit from the use of the technology at a predefined cost. With a wide variety of vendors, configurations, and lease expirations, a typical lessor’s technology risk is spread across a broad spectrum of clients. When this portfolio diversity is combined with an efficient remarketing operation, the lessee benefits further . Initially with a lower lease rate and later with an efficient source of additional capacity. In contrast to the lessor’s large, diversified portfolio, most end-user buyers of technology have a great deal of concentrated remarketing risk as a result of standardization on a single technology and single supplier for a given solution. Few users of technology have developed a core competency in equipment remarketing because it is not core to their business. The lessor, on the other hand, is clearly in a better position to assess,manage, and absorb the residual asset risk associated with a technology acquisition.