ELEMENTS OF EQUIPMENT LEASING CONTRACTS
A lease is in essence an extended rental agreement wherein the owner of the equipment (the lessor) allows the user (the lessee) to operate or otherwise make use of the equipment in exchange for periodic lease payments. There are a number of reasons that companies, sometimes, prefer to lease equipment rather than buying it. For example, there may be good tax reasons. If the operator cannot use the depreciation tax shield, it makes sense to sell the equipment to someone who can. Also the lessor may be better able to bear the risk of obsolescence, or be in a better position to resell second-hand assets. The lessor may be able to offer a very good deal on maintenance. Finally, it may be much less costly in time and effort to arrange a simple lease contract on a standard item of equipment than to arrange a normal loan.
Types of Equipment Leasing
The two primary types of leases are operating leases and long-term leases. Operating leases are characterized by short-term, cancelable terms, and the lessor bears the risk of obsolescence. These leases are generally preferable when the company needing the equipment needs it only for a short period of time. Under the usual terms of such agreements, the lessee can usually cancel an operating lease, assuming prior notice, without a major penalty. Long-term non-cancelable leases which are also known as capital, full payout, or financial lease, are sources of financing for assets the lessee company wants to acquire and use for longer periods of time.
Most financial leases are net leases, meaning that the lessee is responsible for maintaining and insuring that asset and paying all property taxes, if applicable. Financial leases are often used by businesses for expensive capital equipment. In addition to these two basic leasing models, there are a considerable variety of other lease arrangements that are often used. These leases, each of which combine different financial and tax advantages, are actual hybrids of financial and operating leases that reflect the individual needs of lessor companies. For example, full-service leases are leases wherein the lessor is responsible for insurance and maintenance (these are commonplace with office equipment or vehicle leases).
Net leases, on the other hand, are leases wherein the lessee is responsible for maintenance and insurance. Leveraged leases, meanwhile, are arrangements wherein the cost of the leased asset is financed by issuing debt and equity claims against the asset and future lease payments.
Small business experts caution prospective lessees to keep in mind that lease rates can vary considerably from one lease company to another. Lease companies also may charge different rates for the same piece of equipment, depending on various characteristics of the business that is seeking the lease. Factors that can impact the lease rate include the credit history of the lessee, the nature of equipment wanted by lessee, the length of lease term, and whether the lessee or lessor is the primary beneficiary of tax credits associated with the transaction.
Elements of Equipment Leasing Contract
Ten major terms of most equipment leasing contracts are delineated below:
- Duration of the lease
- Total rate of lese payment due the lessor
- Specific financial terms (date of the month that payment is due , penalties for late payment, etc.)
- Residual values and purchase options
- Market value of equipment (necessary for insurance purposes in the event of lost or damaged equipment)
- Tax responsibility
- Equipment updating or cancellation provisions
- Lessee renewal options
- Penalties for early cancellation without good cause
- Miscellaneous options (security deposits, warranties)
Finding a Leasing Company
Business consultants and long-term equipment lessees agree that leasing companies vary considerably in terms of product quality, leasing terms, and customer service. Small business owners should approach a number of lease companies if possible to inquire about lease terms. They should then carefully study the terms of each outfit’s lease agreements, and check into the reputation of each company (present and former customers).
Finally, it is also important for entrepreneurs and business owners to take today’s fast-changing technology into account when considering an equipment leasing arrangement. Because rapidly changing technology can cause an asset to become obsolete before it wears out or the lease expires, you will want to be sure the provisions of your lease permit exchanges for more advanced equipment or replacements, as they become necessary.
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