An equipment lease is a long-term rental agreement for an equipment which can be used to perform one function or the other in an organisation. How equipment leasing typically works is that a company sets up a contract with the owner of a piece of equipment where they agree to make regular payments, and in exchange, they use their equipment during the lease duration.
A lease on its part describes an agreement that lasts 12 months or longer. Anything that comes shorter than that range is referred to as equipment rental. Some leases are designed in such a way that when the renter pays off the money agreed on the equipment, they get to own it by the end of the contract. This is a typical way to finance a purchase as well as rent equipment.
How Do Equipment Leasing Work?
Essentially, leasing can be viewed as an alternative small business financing option. It’s a way to help you get what your business needs now with less money out of your pocket on the front end. Coming down to the basics, leasing transactions involve a contract between a lessor (usually equipment dealers or financial firms who specialize in leases) and a lessee (that’s the person leasing the equipment).
The lessor buys the equipment outright from the manufacturer. The lessee is then allowed to use the equipment for a period of time as long as they hold up their end of the bargain and make the agreed-upon monthly payments on time to the lessor. Depending on the type of lease, once the lease is up, the lessee surrenders the equipment back to the lessor, or they may have the option to buy the equipment.
Of course, every lease is different, but it’s not unusual to find companies willing to offer two- to five-year leases with interest rates in the 8.5% – 20% range. Your exact rate and terms will vary depending upon your credit, the type of equipment you’re seeking to lease, and even your business’ industry.
You’ll generally need a decent personal credit score to qualify for the most attractive rates and terms. Some types of equipment you might be able to secure with an equipment lease include: computers, printers, vehicles, furniture, heavy equipment, medical equipment, specialized equipment, restaurant equipment, etc.
12 Smart Ways Equipment Leasing Companies Make Money
Because specialized business equipment is such an integral part of running many businesses, this is what underscores that stability of the industry. Indeed today, there are many companies lining up to provide leasing options to stranded businesses. In fact, the world of equipment leasing is quite competitive.
At this point, you may be wondering how leasing companies make their money. The obvious answer is leasing equipment for cash, but it may interest you to know that this is not the only way equipment leasing companies earn their pay.
There are a number of ways for money to be made through an equipment leasing business model, and these include, interim rent, retained deposits, fees, lease extensions, non-compliant return charges, fair market value definitions and end-of-lease buyouts for equipment that can’t be returned. These points are explained thus;
Table of Content
1. Interim Rent
When equipment leasing companies provide equipment before the commencement date of the lease, lease agreements often permit them to charge full rent (pro-rated) for the period between delivery and the lease commencement date. Lessees need to be aware that if the amount of this interim rent isn’t capped in the lease agreement, they can be exposed to budget-busting additional costs.
2. Retained Deposits
Another way equipment leasing companies make money is through retained deposits. Leases often require deposits and other upfront fees (commitment fees or restocking fees) and lease agreements typically include language that makes these deposits nonrefundable under predictable circumstances. Lessee should attempt to guarantee reasonable deposit refunds, but if a lessee almost never get deposits back, this expense should be included in the all-in cost of leasing.
3. Lease Extensions
Yet another way equipment leasing companies make money is through extending leases. Equipment leasing companies seek to structure lease agreements so that lease extensions are almost a certainty. They accomplish this goal with provisions that make it extremely difficult for lessors to comply with notice and return requirements, with non-compliance often resulting in automatic lease extensions.
4. Non-Compliant Return Charges
Equipment leasing companies often include “all-but-not-less-than-all” return conditions, which stipulate that rent for an entire schedule of equipment will continue in full force until every piece of equipment on the schedule is returned.
Lessees should approach all-but-not-less-than-all conditions with extreme caution, because in addition to leading to lease extensions, they can result in substantial fees. Other types of return conditions can also be costly, so it’s imperative that lessees carefully examine lease agreements for the risks posed by non-compliant return.
5. Fair Market Value Definitions
Another pitfall for lessees is a failure to adequately define the fair market value (FMV) at the end of the lease, which is what lessees must pay if equipment return is unfeasible and they don’t want to extend the lease. If the lease agreement essentially allows the equipment leasing company to name FMV, lessees who can’t return the equipment will most likely either have to pay an inflated FMV or continue to pay.
Even if mutual agreement on FMV is required, a lessee can find itself in the same position because lease rents will continue until mutual agreement is settled on.
6. End-of-lease Buyouts
When lessees are put in a spot where they must either extend leases or pay the often-excessive FMV for the equipment, they sometimes chose the latter. While equipment leasing companies generally prefer lessees to extend leases, they can also profit on the sale of the equipment at a price favorable to them.
7. Prepayment Penalties
Most lessees prefer to sign a lease agreement that offers them the right to terminate their contract early due to a number of reasons such as not needing the equipment anymore or the equipment becoming obsolete. In such a case, the leasing company will charge the lessee an amount that is equal to a predetermined termination value. If the lease termination value is properly structured, it could be the perfect way to make a profit.
8. Upgrade Financing
Leasing companies can make money when a lessee requests for an upgrade to the equipment they currently have or request for the lease contract to be modified. If the upgrade does not have a stand-alone value or is not readily removable, the leasing company will pay for the upgrade. In such a case, the lessee has two choices: to either buy the equipment with their own money or agree to the terms of the lease.
9. Excess Use charges
Another way equipment leasing companies make money is through charges accruing from excess use. When equipment is returned in good condition, the end of lease sale profits will be much higher. One way that leasing companies can ensure that their equipment remains in good condition is to put strict guidelines on how to use the equipment.
If the guidelines are not followed, the company can exert penalty charges, which can be paid at the end of the lease. The penalty charges are meant to make up for the reduced end of lease sales. Excess use charges can provide a great way to make profits.
10. Interest Charges
Financing profit, also known as financing spread is one of the most obvious ways that leasing companies make money. The greater the financing profit, the higher the interest rate charged. If for example, a leasing company borrows money at an interest rate of 12% per annum and charges a lease interest rate of 15%, then their financial spread would be 3% per annum.
The equipment leasing industry is a multi-billion dollar industry and very competitive at that so many leasing companies often price their lease rates with little or no finance profit. This forces them to look for other means of making money, which brings us to the next point.
11. Tax Benefits
In multimillion-dollar equipment leases, tax benefits available to leasing companies play a critical role in computing anticipated profits. Calculating transaction tax benefits is very difficult but the good news is technology has allowed the invention of analysis software that makes it much easier.
As the equipment owner, when the leasing company leases equipment, they have the right to claim equipment ownership tax benefits. Moreover, there are other tax benefits such as interest charges on loans for long-term equipment in the event that there are leveraged lease transactions.
The lessee on the other hand will be entitled to deduct rent payments as a business expense but they cannot claim tax benefits on equipment ownership. Typically, when a leasing company lowers its rent, it can still realize a profit by taking into account equipment related tax benefits.
12. Residual Earnings
When setting the lease rents, a leasing company’s main aim would be to have enough lease term rents to pay back any equipment loans, return equity investment, and make a profit with any sale made at the end of a lease. This is usually possible in small ticket transactions. If the transaction is a multi-dollar one, this would be rather impossible because of the highly competitive industry.
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