Published Birmingham Business Journal June 9 2003:

Fiscally strong businesses aren't worried in the lease
By Monte Smith

Equipment lease financing has deep roots in the United States, first utilized to finance the use of horse-drawn wagons in the 1700s. The mid-1800s railroad expan¬sion brought about what we consider leas¬ing today: third-party companies arranging financing, purchasing the equipment, then leasing the equipment to the railroad industry.

Today eight out of 10 commercial companies, ranging from "mom-and-pops" to Fortune 500 companies, lease some form of their capital expenditures. The equipment leasing industry accounted for an estimated $270 billion of equipment acquisitions in 2002, and generally sums about 31 per¬cent of the total equipment financed in the United States annually.

Many business owners and financial officers have the misconception that equipment leasing is for startup companies or businesses that cannot obtain conventional financing. Not true. Leasing affords companies much higher-end technology than they could afford, with no down payment or worry about obsolescence. Leasing frees up cash flow and keeps lines of credit open. But what attracts many business owners is the tax advantage. Beginning with the airline industry, financially strong companies began leasing long-life assets for shorter periods of time, gaining a significant tax advantage.

In many instances, leasing can be advantageous to a company acquiring expensive equipment that holds its value over a long period of time. These generally are structured as operating leases in conformity with FASB 13 (a standardization for lease accounting and reporting) for tax purposes and permit the company to treat all pay¬ments as tax-deductible.

For example, a construction company may choose to lease a seven- or lO-year depreciable asset over a much shorter peri¬od, effectively "writing down" the asset faster than allowable by conventional methods. At the end of the term, typically 24 to 36 months, the lease can be reworked to continue payments or can be purchased by the company; at which time they can treat the equipment as an asset and begin depreciating it, whatever is more beneficial.

Avoiding Pitfalls
Leasing is one of the few ways businesses can avoid being penalized by the AMT (Alterative Minimum Tax). Congress established the AMT in 1986 to ensure large corporations paid their fair share of taxes in order not to burden the individual taxpayer. Oftentimes a company can enter an AMT situation by excessive depreciation. A company can navigate around this AMT situation by acquiring the equipment their business needs through an equipment lease, avoiding depreciation while decreas¬ing their tax liability.

High taxes aren't the only pitfall leasing helps companies avoid. Frequently a finan¬cially solid company will make the mistake of paying cash for equipment, causing a potential problem. At the time of the pur¬chase the company may have been in a position to pay cash. Business may slow or a cash crunch may ensue, causing the owners to wish they had leased or financed the equipment. However, there is a solution.

Depending on the value and type of equipment, the owner can sell the equip¬ment to the leasing company and enter into a long-term lease, recouping a substantial portion of the cash outlay and effectively matching revenue with asset life and payment obligations.

According to The Wall StreetJournal, the average internal rate of return for middle-market companies in the United States was 14.4 percent for the 10-year period from 1990 to 2000. An owner insisting on paying cash for capital expenditures must first compare the internal rate of return of the company with the cost of financing the asset.

In other words, will financing the asset (either by leasing or conventional means) be more cost -effective than cash utilized for company growth or other internal operations? With interest rates at historic lows, the general consensus is to finance.

Restrictive covenants
Conventional banks will require companies to adhere to certain financial covenants. These are restrictions imposed by the bank on a business in order to lend money to the company and typically are measured quarterly or annually; depending on the size of the credit and risk associated. Financial covenants range from maximum debt to net worth ratios to minimum cash flow requirements. Capital expenditure covenants limit or cap equipment purchases and can hamper an owner or manage¬ment to add needed equipment. Operating leases are ideal for this situation, allowing the company to acquire required equip¬ment since leases technically are not classified as a capital expenditure. Leasing also allows a company to stay in compliance with maximum debt ratios since certain types of leases are not classified as debt on the balance sheet. While many companies will lease some asset in their business lifetime, most will not experience the convenience, satisfaction and professionalism of leasing equipment with an independently owned leasing company. Don't be fooled by conventional financing that does not provide your business with today's needed competitive edge.