Which is Better...Financing or Leasing?

You've determined what equipment you need to grow your business - woohoo! Now you need to figure out how you'll pay for it. There are several factors to consider:

Is cash a viable option?

Will you be financing the purchase?

Do you have specific tax needs?

Cash is King (and why you might want to hold onto it)

Cash is always the most convenient option: it's fast and interest-free. But it's likely not the best option. If there's one thing I've learned in my 6 years working with small businesses, it's that cash is the lifeblood of a business. We all know it's important to have a healthy amount of working capital (cash on hand) available to use for daily expenses. Payroll, utilities, supplies, and rent are always present.

We've also had a recent refresher course in how important it is to have emergency cash available to get through unexpected events: (hello Covid pandemic).

Using cash for a large equipment purchase can often leave bank accounts uncomfortably low. Without ample cash on hand, operating and growing a successful business just isn't feasible over time. Hanging on to your "extra" cash by opting to finance your new business equipment might be the best decision you ever make.

The Meat & Potatoes: Lease vs. Loan

For small businesses, there are two primary methods of financing: leasing and traditional bank loans. So which is better, financing or leasing? I mean, we ARE in the business of lease financing...so naturally we'd love to say our type of financing is best for everyone (wink). But it truly depends on your needs and situation. Check out our lease vs. loan rundown...

Bank Loans

Most of us are familiar with traditional bank loans. Like an auto loan, you own the equipment, but the bank will put a lien on it until it's paid off. Once you make the last payment, the bank will release the lien and you own the equipment free and clear.

Rates, terms, and requirements can vary depending on the economy, the lender, your qualifications, and the equipment. Banks are highly regulated (not necessarily a bad thing), making them generally more conservative and risk averse. They often have a set credit model you must fit within to be approved for financing. They also have strict borrowing limits...potentially shutting the door on financing future purchases.

WHAT COULD THAT REGULATION MEAN FOR YOU?

• Longer review times (which might mean a delay in your purchase).
• High amount of documentation needed (business financials, taxes, etc.).
• Strict guidelines = greater cash down requirements, higher rate, shorter terms, inability to qualify for additional credit, etc.
• Financing is difficult to obtain for start-ups or challenged credits.
• Your minimum payment may change over the course of your term.

LOANS AT TAX TIME*

With a loan, you can opt for a standard depreciation schedule or utilize Section 179. Under Section 179, you may be able to deduct the entire cost of the equipment in the year it was acquired and put into use. (You can also use Section 179 with a cash purchase or Capital Lease structure...just not with a Tax Lease.)

Lease Financing

Now let's talk leasing. If you've leased a car in the past (or been warned about it), you might assume an equipment lease works the same way...that you'll be stuck with an outrageous buyout at the end of term. Not the case here!

In reality, the vast majority of equipment leasing is "lease-to-own". Over 90% of customers take ownership at the end of their lease term with an affordable buyout (anywhere from $1 to 10%).

WHAT IS EQUIPMENT LEASING?

A lease is a form of financing in which you make "rental" payments over a set term. The payments remain the same throughout your term, and there's a pre-determined buyout amount at the end.

There are two primary lease structures available: Capital Lease or Tax Lease. (FYI: both options are customizable and able to be tailored to your needs!)

Let's explore the differences:

1. CAPITAL LEASE:

A Capital Lease, in simple terms, is a purchase. The most common Capital Lease structure is a EFA or $1 buyout.

(Fun fact: most leasing companies won't invoice you for that last dollar at the end, you simply take ownership.)

For tax purposes, the IRS views a Capital Lease no differently than a bank loan or a cash purchase. Likewise, you can opt for a standard depreciation schedule or utilize Section 179.*

2. TAX LEASE:

A Tax Lease (or Operating Lease) will have a buyout at the end of the term, and the option to return the equipment. The most common buyout is 10%. For example, if you lease a $50,000 piece of medical equipment, the buyout required to take ownership at the end of term would be $5,000.

There are some additional qualities of a Tax Lease structure we want to highlight:

• Tax Leases come with a lower payment. (Tip: I tell people to think of the 10% buyout as a 10% down payment that they don't have to pay until the end of their lease term.)
• Tax Leases leave the door open to return and/or upgrade equipment. This feature is most beneficial with digital technology that's rapidly advancing. You're able to return obsolete equipment and easily upgrade to the latest and greatest. (You essentially avoid a buyout and get new technology...all while maintaining a similar monthly payment to what you're used to!)
• The IRS views a Tax Lease as a simple business expense, just like your building rent. What this means is that your full monthly payment is 100% tax deductible over the term. For those of you who prepare your own tax return, this is an extremely easy way to calculate your tax deduction. Simply add up the money paid to your leasing company in a calendar year - that's the amount you can write off!

*Pro Tip: You should always consult with your tax advisor when making a large purchase! They can help you determine what the best structure is for your business, for this purchase, in this tax year.

Here for You.

Here at Baceline Capital, we thrive on helping small businesses grow. We love getting to know each customer individually and discovering the best financing method for them. Leasing might not be the right option for this equipment purchase, but it could be the next time around! When that time comes, we'll be right here waiting!