Equipment Leasing Mistakes That Can Cost Your Business A Fortune
Rod McHenry, vice president of finance for a document imaging company, thought he had a great reason to celebrate. He had signed an incredible $ 370,000 lease proposal that covered computer servers, workstations, software, and other network equipment. McHenry believed he had obtained an incredible lease rate, culminating in weeks of negotiating an acceptable equipment price with the equipment supplier. The proposal guaranteed the closing of the lease and offered a 2% refund of the “commitment fee” paid by McHenry’s company if the leasing company did not approve the loan within two weeks. Little did McHenry know that signing this proposal would push his company into the “dark zone” of equipment leasing. Ultimately, his firm would shell out more than $ 15,000 in legal fees seeking the landlord’s performance, only to learn that the landlord was already insolvent and mired in several similar lawsuits.
Like McHenry’s employer, thousands of American companies rent equipment each year, many of them without paying much attention to potential errors. Rod McHenry was the victim of a potential pitfall, but there are several areas that deserve careful attention.
Falling for the lowest rate
One potential bump that many potential renters face is basing their leasing decision solely on the lowest monthly payment. Even at first glance, making a decision based on the monthly payment makes little sense. First, these amounts give only a partial picture of the total rental price. An accurate discounting of cash flows through a present value analysis, including advance lease payments, monthly payments, security deposits, and fees, can often change the outcome of the lowest lease offer. Ensuring that each lease proposal is reduced to a present value calculation ensures that you will be comparing apples to apples. Even if you make accurate price comparisons, pricing alone does not take into account several important factors, which could save you a package in the long run and prevent your business from making mistakes. To avoid obstacles in this area, list and evaluate your top priorities for a lease agreement. Consider factors such as: choosing the right leasing partner, balance sheet considerations, tax considerations, choosing the right way to lease, avoiding harsh lease terms, and getting enough lease flexibility.
Failure to verify landlord references and financial status
As Rod McHenry discovered, perhaps the area with the greatest potential for a misstep is landlord selection. Failure to investigate and make an accurate decision from the leasing partner can result in transaction delays, misrepresentations, default, unexpected fees, or even fraud. Like many industries, equipment leasing encompasses many players with varying degrees of experience, expertise, integrity, and financial strength. When selecting the best leasing partner, obtain enough information from the bidders to perform an effective benchmark check. If possible, also obtain financial information from the bidding lessors to assess their financial situation. Get reports from Dunn and Bradstreet on each bidder. Request and verify references from clients, suppliers, banks and businesses. Perform an internet news and message board search to make sure that bidding landlords are not the subject of unresolved scandals or problems. Most reputable lessors belong to one of the major equipment leasing trade associations (ELA, EAEL, UAEL or NAELB). Call the appropriate association for a referral. Lastly, ask. Consult with your attorney, accounting firm, banker, friends, and associates who can make recommendations based on past experiences.
Not fully understanding the lease
Not reading and understanding the main terms and conditions of the equipment lease can cost your business a lot. While most leases include similar terms and conditions, there can be noticeable differences. For example, most agreements cover the responsibility of the lessee to pack the equipment and ship it to the lessor at the end of the lease, if the lessee chooses to return the equipment. Some leases require the tenant to do so before the last day of the lease, perhaps depriving the tenant of a week or more of use. Additionally, some agreements require the renter to pay for uninstall equipment, packaging, and shipping to any destination within the US, which can be expensive. You can save money by negotiating many of these points. Read the lease carefully, get legal advice if necessary, and negotiate points that can save you money.
Making the wrong decision between fair market value and buy-out leases
At the top of the list of potential leasing errors is choosing the wrong form of leasing for the planned use of the equipment. Failure to choose wisely can result in significant additional rental expense. Equipment leases fall into two broad categories: 1) leases designed to transfer ownership of the equipment to the lessee at the end of the lease (advantageous purchase / equity leases) and 2) leases intended to allow the leasing company to retain ownership equipment (fair market value or operating leases).
If you plan to keep the equipment beyond the term of the lease, it is generally more economical to enter into a profitable purchase / equity lease. During the lease, you pay the landlord a rate of return plus the cost of the equipment. At the end of the lease, you receive the title to the equipment for a nominal fee. If the equipment is subject to rapid obsolescence or if you are confident that you will return the equipment at the end of the lease, a fair market value or operating lease may be advantageous. What you get in a fair market value or operating lease is the flexibility to eject the equipment at the end of the lease. Additionally, this form of leasing can lower your lease rate as the lessor returns a portion of the anticipated residual value to your business in the form of lower payments. If your business has reasons to minimize liabilities on the balance sheet, perhaps due to bank finance arrangements, an operating lease might be attractive. In these leasing situations, balance sheet concerns may outweigh the desire for the lowest lease rate. When choosing a form of lease, look at the period of intended use of the equipment, the potential for obsolescence of the equipment, balance sheet considerations, income tax considerations, and any other factors that may influence the choice of lease.
Failure to evaluate the supplier’s service: equipment leasing agreements
Entering into a ‘hell or high water’ equipment lease that involves proprietary equipment required for a multi-year service (such as alternative energy or telephone services) can lead your business into a situation ripe for failure. Even under the best of circumstances, a ‘hell or offshore’ equipment lease (one that requires non-cancellable payments) entered into in connection with a service agreement carries a certain degree of risk. In many cases, the lease is provided by a leasing company independent of the service provider or later sold by the service provider to a lessor. The potential problem is the result of your business being stuck on lease payments for equipment it can no longer use, should the service provider fail or stop offering the service. The best protection against this potential danger is to avoid these types of arrangements. If you must enter into such an agreement, make sure the service provider is financially sound, reputable, and has a long history of providing excellent service. Also, since these transactions always carry some risk, make sure that an abrupt interruption in service does not have a material negative impact on your business or cause financial difficulties.
Ignoring the deadline on the end-of-lease notice
While not a deadly mistake, failing to provide timely notice at the end of your lease can result in significant additional leasing expense for your business if you plan to return the equipment. Many leases have provisions that require the lessee to notify the lessor of the lessee’s decision to return the equipment at the end of the lease. If you violate the notice period, the lease enters an often unfavorable automatic renewal period, usually one to six months. If you intend to return the equipment at the end of the lease, make sure your company notifies you in time. It can save your business a bundle on avoidable leasing expenses.
Underestimating the time it takes to close the lease
Not allowing enough time to go through the planning, proposal, approval and documentation phases of the lease can result in additional cost. A rushed process can lead to poor landlord selection, approval delays, documentation errors, or poorly negotiated lease terms. Except for small ticket transactions (less than $ 75,000 to $ 100,000) where directors’ personal guarantees are involved, most lease transactions take at least three weeks or more to close. Although part of the time is consumed in the bidding and credit review processes, much of it can be consumed by administrative matters. Obtaining certificates of insurance, submitting UCC financing statements, reviewing and negotiating the lease all contribute to the time it takes to get to the closing of a lease. The best way to manage the lease closing process and save valuable time and money is to plan ahead. Be sure to set criteria for the lease you are looking for, prepare a package containing the information all bidders would like, get a closing list from each lease bidder, and answer all requests / questions raised by landlords. bidders in a timely manner.
While you can’t always avoid the downsides of equipment leasing, you can take steps to avoid downsides that can cost your business a dime. Plan ahead and do your homework before starting the lease bidding process. Give high priority to selecting an experienced leasing provider with high integrity and good experience. Also, with leasing transactions that represent significant obligations to your business, hire a competent attorney to help you review and negotiate the equipment lease.