Doing the Math
What Kind of Lease is Right for Me?
Why rent, when you can own? In the leasing world, the answer is: It depends.
Leasing can offer a variety of benefits that cut across equipment types such as maintaining cash or preserving lines of credit, avoidance of risk on asset utilization or obsolescence, and flexibility gained from having access to a wider range of funding options.
Different solutions and different types of equipment are available. Having a solid understanding of the different options is essential for making the right decision at the right time.
Leasing can offer a variety of benefits that cut across equipment types, such as maintaining cash or preserving lines of credit, avoidance of risk on asset utilization or obsolescence, and flexibility gained from having access to a wider range of funding options. Ofcourse, each business will have to factor in its own situation and financial considerations. The decision must be company-specific.
For example, for Steve Ragaller, VP and CFO at the diversified manufacturer Cretex Companies, the calculation is pretty straightforward: “It’s all operating leases. We have never done a capital lease.”
Why is that? Because, Ragaller says, operating leases—essentially, time-delimited rentals—make the most sense for markets and equipment that can change rapidly. These would include Cretex’s high tech medical equipment line, as well as its (also high-tech) aerospace components business. The company’s concrete business, on the other hand, employs much longer-lived equipment that can run for years without needing any significant upgrades.
“The technology doesn’t change there as much and our growth hasn’t been as fast there as it has been in medical and aerospace,” notes Ragaller. Under those conditions, he would rather simply purchase the equipment outright.
The variables going into the leasing calculation, however, are not always easily defined. At Edward Don, the nationwide supplier of equipment for the food services industry, Jim Jones is both CFO and COO. Like Ragaller, Jones takes more than a passing interest in the smooth operation of his company’s production lines, and for him, the key question is, “What happens at the end of the lease?”
If it’s equipment that is central to the company’s operations and with a long useful life, Jones tends to avoid operating leases that have a fair market value residual or buyout. If the buyout or residual appears high, and having the lessor or bank reclaim the equipment will cause serious disruption to the business, then the company needs to protect its investment. For example, with the equipment racks that fill Edward Don’s facilities, Jones explains, “At the end of the fifth year, I don’t want somebody coming in and saying, ‘I’m going to tear out all of your rack.’ I’m depending on this rack to run our business for the next 20 years.”
Jones insists on having a guaranteed buyout provision for these leases, to avoid the risk of disruption when the lease runs out. Essentially, his policy is to ultimately “own something that has a long useful life”—like equipment racks—“and lease things that have a short useful life”—like technology.
But wait—there’s more to it than that. “What gets murky is the in-between, sometimes,” Jones continues. For instance, for one “fairly significant investment,” as he puts it, “my bias was to buy it because I want to own it long-term.” But the bank Jones was working with came back with an attractive interest rate on an eight-year lease that had a five-year buyout clause. “So I could effectively get to owning the equipment by leasing in the short term—for the first five years—and then buying at the end of the fifth year for a fixed price,” Jones concludes.
It’s the best of both worlds—so long as “you know all the variables were nailed down, so it was analyzable,” cautions Jones. For example, absent the protection of a guaranteed buyout, Jones says, “That shoves me over to short-term leases,” which he uses for items such as computers.
Bob Bedford is a Growth Leader for Access GE, GE Capital’s program for sharing best practices and lessons learned with a wide range of customers. Bedford also weighs in on the need to consider a full range of options in the leasing market. “The more solutions you can come up with for customers where they feel like they have a little more flexibility, the better,” he says. For example, a company may start out with a relatively short 24-month lease for production equipment, because it’s booked a 12-month backlog of orders and the outlook for another 12 is good. By adding in a fixed purchase option, says Bedford, “they basically know they can have a test period. Going in, they will know they can walk away in 24 months, if they want, or buy it for the fair market value.”
In point of fact, the same CFO could very well come up with different solutions to the leasing equation for different types of equipment, or even at different times for the same equipment. Having a good grasp on the variables involved in this calculus is essential for making the right decision at the right time, for the right reasons.
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