Stop the Financial Waste

Patrick Baldwin Private Banking and Investment Group, Merrill Lynch Chicago

EQUIPMENT IS THE LIFEBLOOD of any waste management operation. And one popular equipment acquisition method for many U.S. businesses is leasing. According to Access Equipment Leasing, more than 35 percent of all business equipment is leased. Traditionally, anything associated with the operation of your business can be leased, including all types of capital equipment, hardware and software.

There are many advantages leasing holds over other traditional forms of financing that should make you think twice before making a purchase. Leasing offers more control over and less strain on corporate cash flow. Operating profits come from using equipment, not owning it. Therefore, cash is better served investing in areas that can lead to increased revenues rather than in equipment that will quickly depreciate in value. The cash saved by leasing can help to expand sales, develop new marketing programs, provide customers with quantity discounts, increase inventories or simply build cash reserves.

A young company may lease primarily to conserve cash. Leasing also is a good way for mature, profitable companies to keep bank credit lines open.

Leasing also provides businesses requiring up-to-date technology the ability and feasibility to upgrade equipment. Today's machinery is rapidly being updated. If you've purchased equipment with cash, you could miss out on the opportunity to upgrade. This could cause you to lose business to someone who has more technical capabilities.

Most leasing companies are flexible and will find ways to structure lease transactions to fit your needs. This allows you to make the most of lease structuring variables, including number of payments, amount of the advance payment, purchase options, interim rent and other options.

Leasing companies usually require lower down payments than financial institutions such as banks. If a company wanted to rent a piece of equipment such as a compactor, it is likely that only one or two lease payments will be required in advance, rather than the sizable down payment usually required on a purchase loan. If you play your cards right, installation and other incidental costs can be included as part of the lease payment instead of being paid in advance with a large down payment.

Leasing also can be less constrictive. When lending to a company, banks typically impose restrictive covenants into the loan agreement. The covenants are used by the bank to help minimize — or at least to bring to its attention — any potential default on the loan by the borrower. Loan covenants, which aim to minimize the lender's risk, often can be very restrictive, such as forbidding mergers or acquisitions, or having to maintain a certain net worth. Lease agreements, on the other hand, rarely contain restrictive covenants, thereby offering greater freedom than a loan.

Leasing can increase tax benefits. The American Jobs Creation Act of 2004 will extend until 2008 many of the benefits for business owners provided in the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) of 2003. This act provides advantages for small business owners who use commercial equipment leasing to lower the after-tax costs of new financing.

However, one benefit from JGTRRA that will not be extended is bonus depreciation. JGTRRA allows businesses to take a first-year bonus deduction of 50 percent of equipment costs, with the remaining 50 percent of the cost depreciating over the normal depreciation life. This bonus deduction applies only to new equipment acquired after May 5, 2003, and placed in service before Jan. 1, 2005, or by Jan. 1, 2006, for property with a longer production period. With this benefit expiring, leasing may provide greater tax benefits than buying.

Another important aspect of leasing that has influenced its popularity is that companies generally have the ability to purchase the equipment at the end of the lease term. Structured correctly, fixed-purchase-option leases can combine the benefit of leasing with the advantage of owning the equipment.

Whether you are a business owner who watches the bottom-line each day or a key employee looking for new equipment options, leasing can be a good choice. It allows businesses to avoid technological obsolescence, to benefit from off-balance-sheet operating leases or to take advantage of the many flexible-structuring options available in the lease.

However, it is important to seek the advice of qualified advisors who can look at leasing decisions from your company's perspective. Your advisory team should include a financial advisor, tax advisor and attorney to help address your company's immediate needs, such as cash flow and equipment, and future needs, such as succession planning acquisitions. With the proper information, no matter what the size or stage of your business, leasing is one option you should not throw away.