We first gave an overview of equipment leasing in general, and then got into terms, phrases, and definitions. That was pretty interesting because I’m sure a lot of folks didn’t realize terms like “monthly rent” applied to equipment leases as well. 

We then got into the wear and tear clauses, and what they entail. We also learned it’s a little deeper than “don’t scratch the paint”. Mixed into those two posts was the residual value, and how the types of lease, length, and wear and tear all impact the residual value.

I then got into the topic of insurance, and the why’s and how’s of it all. This is pretty important because a lessee needs insurance even if they don’t own the item, and (surprise surprise) their general insurance may not cover the leased equipment like they think it will. 

And I just used the word “lessee”, so it’s good to point out we also learned the difference between lessee and lessor (the lessee is you, and the lessor is the lender/leasing company, in this case, Crest Capital).

So are we done with leasing? As far as equipment leasing terms and definitions are concerned we are, but I do have a few more points I am going to cover in the near future. Specifically, I’ll do a post or three about end of lease options (lease renewals, purchase options, giving the equipment back, etc.) And it’s also prudent to discuss what happens in the case of early termination. Look for them shortly. 

In the end, leasing is an excellent way to acquire the equipment you need. And to put it into a 2023 context, it’s also very attractive right now due to economic uncertainty regarding rates and inflation. Leasing lets you get the equipment you need without the longer commitment. 

And on that note, let me also state that almost any type of equipment can be leased. Too many people forget this, thinking that only vehicles can be leased. Not true at all. This was posted earlier, but let’s do it again: here are all the different equipment lease types offered by Crest Capital.  

It’s no secret as to why this blog is called “The Lease Guy”. Leasing is awesome, and we love it. And if you need equipment, you will too!

The general purpose of this clause is related to the residual value I mentioned last post. When a lease agreement is made, the Lessor (that’s us) has an expectation that the equipment will have a certain value at the end of the lease. The Lessee (you) are generally paying for the usable life of the equipment during the time you have it. 

In order to arrive at the predicted residual value, the equipment must be both used in the manner it was intended, and also be maintained in accordance with the manufacturer’s specifications. 

In general, the terms regarding maintenance and wear and tear will look similar to the following (note: these are simply big-picture examples, and not legal statements):

The Lessee will: 

• Keep the equipment in good condition and make non-warranty repairs at its own expense (depending on the equipment, there may be a further provision stating that repairs need to be performed by an authorized/licensed entity.) 
• Keep the equipment properly maintained and serviced as per the manufacturer’s specifications/recommendations (again, perhaps by an authorized service entity. Oh, and keep records too.) 
• Ensure the equipment is used properly, and only by competent, trained employees.
• If applicable, keep/store the equipment at the agreed-upon location.
• Not change or add to the Equipment unless agreed upon.
• At lease end, return the equipment in good condition and working order, with ordinary wear and tear resulting from proper use.
• Make the Lessor aware of any accidents, damage, or similar. 

In most lease agreements, assuming proper and intended use, the residual value is typically spot on. But if it is not at the predicted amount due to abnormal use – if there’s damage, excessive wear, or similar – the Lessee will certainly find themselves responsible for making up the difference between the actual value of the equipment and the residual value. 

*Note that there can be a gray area between what’s considered normal wear vs. excessive wear. The Lessor is the one who determines this, typically by referencing industry guides and manufacturer’s specifications.

It is always best to look at a lease agreement and leased equipment like you would if you were borrowing a tool from a friend, or better still, a beloved family member. You want to give it back in the expected condition, and while it’s with you, care for it as if it were your own. 

Lease Term – This is the total time of your lease. It is usually broken down into months, but can also be calculated as years for ease of discussion (e.g., a 36-month lease and a three-year lease are the same thing). 

The Lease Term will affect your monthly payment in the same way a finance term does – the longer the term, the lower the payment. But the lease term will also affect the ending residual value, which we’ll get to in a second…

Monthly Rent – Can you guess what this is? It’s your monthly payment. It’s sometimes called monthly rent because leasing is often seen as closer to renting equipment than buying it. There, that was simple!

Residual Value – This is the value of the equipment at the end of the lease term. This can either be a calculated value at the beginning of most leases (“assuming normal wear and tear, the equipment will be worth $XX at the end of three years”), or a value determined by the market (in a Fair Market Value lease, the residual value at lease end is, you guessed it, the fair market value.) 

In the case of the residual value being determined at lease inception, it will affect the monthly payment – essentially, you’re paying for the portion of the item’s full value you are using during your lease term. So the higher the residual value (percentage-wise) to the equipment’s overall value will result in a lower payment (this is also determined by lease term – all things equal, a two year old vehicle is worth more than a same model three year old one). 

The residual value is typically the price you can buy the equipment at after the lease is over (or use as the item’s value in a new lease.) 

Lease Rate – Similar to an equipment finance agreement, this is the rate you pay on your lease term. It’s calculated a little differently (instead of straight interest, it’s more a flat fee divided by the term, but it generally works out to similar amounts.) 

Lessee / Lessor – I debated putting these here because they seem a little basic. But you know what? Even I get them confused sometimes.  The Lessee is you, the person or company leasing the equipment. The Lessor is the one providing the lease, in this case, Crest Capital.   

The preceding are the basic terms you’ll run into with any lease agreement, and should get you by in understanding everything pretty well. 

I also talk to many small business owners who feel the same way – they go to their bank who “specializes in small business lending”, and they are told the minimum loan for the special program is $250k. That’s great and all, but the 10-person landscaping company or 8-person accounting firm was only looking for $65,000. 

For us at Crest Capital, most of our customer base are companies that have between 5 and 75 employees. Yes, some are larger (and even a few are smaller), but that’s the market we serve. So when we say we’re a small business lender, we really mean it.

This is important to discuss from time to time, because of what I mentioned previously. A 12-person company goes for a loan, and it’s implied the company is too small to get favorable rates and terms. Nevermind that their revenues well exceed a million dollars a year, they have excellent credit, and the loan will help them grow even more. 

There’s another small layer to this that I want to mention. The person who owns and runs that 12-person company doesn’t think it’s “small”. In fact, that business is probably one of the biggest things in his or her life. They may have spent decades building it up. 

Even further, of those 12 employees, six of them earn full-time salaries. There are four different families whose mortgages depend on that business. Nine college educations will be at least partially paid from this business. A bunch of automobiles, hundreds of meals out, vacations, and countless dollars wasted on “silly” hobbies (according to spouses)… all of it the result of this “small” business.

No, there is no business “too small” for financing. 

As long as a company is successful, has a few years under their belt, and revenues (and credit) are good, equipment financing is available. Quicker and easier than you think, too.    

I’m not really a salesperson at heart, but whenever I talk with a small business owner, I’m probably going to bring up equipment financing. Not so much because I want to bring another client on board (but that never hurts), but more because I truly believe in it. Equipment financing / equipment leasing are far and away the best way for any business, small or large, to acquire equipment.

Last week, I happened to be talking to a small business owner. He owned a tree trimming / tree removal company, and had been in business about ten years. In those ten years, he’s experienced success, and has grown his company from just him and a helper to about 10 people in two different crews. And in this time, he’s bought a few bucket trucks, a crane, 2 large chippers, and other equipment.

Anyway, during our conversation, he said he was looking for another bucket truck, so I handed him a card. And he looked at it and said “Is your jail better than the one I’m in now?” I was a little puzzled, and asked what he meant. He went on a five minute rant about his bank, and how he was in “bank restrictions jail”.

As it turned out, one of the things I mention here often was affecting him – when you finance equipment at the bank, they put a blanket lien on everything your company owns. So he financed a bucket truck, and later wanted to sell his crane privately and buy a new one. But he couldn’t sell the crane privately, even though he owned it outright – it was part of the bank’s blanket lien. He had to jump through all kinds of hoops and ask the warden (his words – he’s really liking the jail analogy) for permission to sell something he already owned.

Well, as you likely know, we have no blanket liens or restrictions on financed equipment, so I’m going to bust him out of jail. Let’s hope I don’t get caught!!

Hmmm, maybe Mrs. Fletch has a thing for the bad boy…

To recap, we talked about leasing in an overall sense, talked about capital leases vs. operating leases, and even discussed leasing vs. financing. Now we’re into the individual leases, and like stated above, we’ll do the most popular lease first – the $1 buyout lease.

In plain terms, the $1 buyout lease is a lease where the company (the borrower) makes payments on a piece of equipment, and at the end of the lease term, “buys” the equipment for $1. Obviously, for a $1 buyout, the payments and term reflect – almost dollar for dollar – a finance loan of similar length (otherwise, buying it out for a single dollar wouldn’t make sense.)

In essence, a $1 buyout lease IS just like a loan, save for the technical classification of ownership (I discussed this with the “leasing vs. financing” post linked above.) While lease payments are being made, the lessee (the borrower) doesn’t technically own the equipment – but if treated as a bargain purchase option lease – it does show up as an asset on the balance sheet. If this doesn’t make your accountant happy, go with a lease that doesn’t have a bargain purchase option (i.e. FMV) as each lease payment can be expensed 100% (as opposed to slow ownership depreciation), and the equipment won’t throw the balance sheet out of whack either (which is a boon to executives whose year-end bonuses are tied to a Return-on-Asset ratio).

But leaving “accounting details while payments are being made” aside, the company still definitely wants the equipment (and wants to eventually own it.) Thus, the $1 buyout lease is structured so the bulk of the equipment’s cost is paid during the lease term, with that final $1 getting it over the hump to actual ownership.

Simple, right? And here you thought a company was getting a sweet deal by buying something expensive for only $1.

Here’s the question:

Hi Fletch,

In a recent blog, you talked about a $1 buyout lease and other Capital Leases, where at the end of the lease, the company then buys the equipment for $1 or some other sum. It seems to me that is similar to a loan (especially the $1 lease). So what’s the difference between that kind of lease and a straight equipment financing loan?

Dave F

Great question, Dave. The short answer is “not much difference at all”. But there are some technical differences.

In a lease, the lessor (the lender) actually owns the equipment in question. In other words, the lessor is seen as the purchaser on the bill of sale, and files a UCC filing to demonstrate such. However, on a finance deal / loan, the borrower actually owns the equipment, and the lender has a lien against the equipment until it is paid in full.

Remember selling your car years ago, and you had to have a “clear title” with no liens, and perhaps even a payoff letter from the company that loaned the money for the car? That’s a good example of how this works.

In some cases, a company wants to “own” the equipment, and wish to peruse a finance deal. Other companies might want the equipment off their balance sheet for a myriad of reasons (which I’ll get into further when I discuss the individual lease types in the next few posts), so they prefer a lease. It’s really up to the company accountant / CFO which one a company will ask for. The finance company has some say here, too – for example, many equipment finance companies don’t lease vehicles anymore, because of sticky situations involving ownership (like the traffic ticket I wrote about recently.)

In the old days, another advantage to the Lessee (borrower) of a Lease was the “owner” was responsible for taxes, upkeep, risks of ownership, etc. But today, all that has been contractually passed to the Lessee.

So realistically, there’s very little difference, as both accountants and the IRS treat a Capital Lease as a Loan in terms of taxes and risk. The only big difference is who “technically” owns the equipment during the time payments are being made, and for many companies, the answer is “it doesn’t really matter”.

I’ve mentioned bits and parts of this before in this blog, but it’s good to revisit these things from time to time for newer readers.

For this post, I’ll list each type of equipment lease and a very basic description, and in future posts, we’ll talk about each one individually.

Note – there are more lease types than I am going to mention – we’re just going to talk about the most popular ones in an equipment leasing sense.

The first thing I will mention are the two basic lease classifications.

• Capital Lease – This is a lease where the company (technically the lessee, but I hate using those terms here as people always get confused) gets the benefits (and drawbacks) of ownership. They are usually used for equipment where the company will likely (or must) buy it at lease end.

• Operating Lease – This is a lease where the company is shielded from the drawbacks (and benefits) of ownership. These leases are better for equipment such as technology, which may have a short shelf life, or equipment the company doesn’t want to retain past the term of the lease, etc.

Then within these two classifications, we have a bunch of lease types that I’ll go over. Here they are in a nutshell.

$1 Buyout Leases are capital leases, and are great when a company wants the tax advantages of my old favorite, Section 179, but is also pretty sure they want to own the equipment when the lease term is over. Thus, they lease it, and at the end of the lease, they then buy it for $1.

10% Option Lease – This is similar to a $1 buyout because the company can buy the equipment for a predetermined cost, which is 10% of the original price, and still provides a lower monthly payment like an FMV lease.

FMV Leases are operating leases. This is where the company/lessee is not 100% sure if they want the equipment. They lease it for a certain period of time, and at the end of the lease, they can either 1) Buy the equipment at fair market value; 2) Give the equipment back; or 3) re-lease the equipment.

10% Put Option Lease – This capital lease is similar to a 10% option lease, save that there’s no “option” at the end – the company buys it for 10% of the original value.

TRAC Leases – This is a lease where the future purchase price is known, and the payment is based on that. It’s used for vehicles only. It can be either a capital or an operating lease, depending on how it’s written.

For the next post, we’ll discuss the ins and outs of Capital vs. Operating Leases, and in the future, we’ll devote a post to each lease.

But for now, let’s continue on with my “what you should look for in a finance partner” series. If you don’t know what I am talking about, see the first two posts in this series here and here. Last time, I finished with telling you that any finance partner should be proactive. Here’s what I mean by that:

It’s easy to understand the concept of offering financing. Finance X for Y years. Do the deal, the payments start, and everyone is happy.

But what about a finance partner that can go above and beyond a simple “straight” financing deal, and could get creative to help you close sales – wouldn’t that be nice?

Here’s what I mean – you ever see those deals that stores sometimes offer – “no payments until 2015”. Or maybe “first payment skipped” or “no payments during the winter months” or something similar? That’s what I am talking about – does your financing partner engage in creative programs that make financing more attractive to your customer? That’s really key, and for some industries, it can make a real difference.

A good example of this is a golf course in the Northeast. They operate (in general terms) April through November. So Dec-March, they make no revenue. Do you think they might like a financing deal that follows this schedule? Now I realize it’s easy to say “hey, that’s business – they should be happy to pay all year – just budget for it”. And you would be correct. But if you’re one of ten golf cart manufacturers, and you’re the only one that can offer “no payments Dec-March” (because you have a really proactive financing partner)… guess what? You have a HUGE advantage.

This is one very basic example, and there are a lot of different “types” of deals, but you get the point: “Proactive = Good”.

So, do you have a proactive financing partner?

As we all know, the economy has had its ups and downs (mostly downs). Well, these ups and downs may affect companies who have leased equipment and the equipment lease term is coming to an end. Perhaps when they signed the equipment lease a few years ago, they didn’t realize the economy and/or sales would be at the levels they are now. Which means owners of expiring equipment leases have a decision to make:

• Take the buyout. Depending on the equipment lease terms, there may be a buyout. The company takes the buyout, and they own the equipment. However, what may have been seen as a manageable buyout in 2007 might not be so manageable in 2009.
• Return the equipment. This is obvious, but can be difficult if you are using the equipment
• Lease new equipment. Ok, maybe you want to return the equipment and lease something newer. Fine…. but many companies don’t really want to replace something that is working fine. There are many companies caught up in this right now – they don’t want to return the leased equipment, but the lease buyout isn’t an option in 2009 either… what to do?
• Extend the lease. Many equipment leasing companies will be happy to extend your lease. This allows you to keep the leased equipment, and keep the lease payment you’ve been accustomed to.

However, with the above, I want to extend a note of caution – you do not want to extend the lease too far. That’s because the leased payment was based on the residual value of the equipment. If you can, try and negotiate a new payment based on the value of the equipment right now (not a few years ago).

Of course, the equipment lease company may not extend the exact residual value you want (after all, you have to understand that they are doing you a favor by extending the lease terms in the first place), but it warrants a conversation at the least.

Ok, I’ll be on vacation for a bit (going on a cruise). See you in a few weeks!