One of the fundamental questions that every small business owner faces is how to pay for new tech equipment that you need to help your business grow or to get your new business started in the first place. Is it better to buy the equipment you need, or should you lease it? What are the advantages and disadvantages to either approach?

There is no universal, one-fits-all answer to the buy vs. lease question. Each business has circumstances that make one option or the other more attractive at different times. Your management philosophy toward buying and keeping assets, the degree that changes in technology affect your business, and your company's financial strength all affect the approach you will take to making this decision. We'll offer you some pointers to help you sort through your options.

Essentially, there are two categories of considerations you need to take into account to make your decision: financial and nonfinancial. Financial considerations include your total cost to acquire the equipment, your business cash flow, potential tax advantages, and benefits to your balance sheet. Nonfinancial considerations include asset-management issues, your technology replacement schedule, technical support, and the cost to dispose of obsolete equipment.

First, it is important to understand how a lease and a purchase are different.


How Leasing Differs From Buying

When you buy a piece of equipment such as a computer, you purchase the rights to the whole value of the equipment you are buying, whether you use it all or not. So if you buy a computer, you own the whole computer until you sell it. Even if you finance the equipment and pay more over time than if you had paid cash, at the end of the loan term you will own the computer outright.

If you lease the same computer, you are essentially renting the right to use the computer for a specific period of time. The leasing company owns the equipment. At the end of the lease term, the leasing company still owns the equipment, and you need to replace it.

The company that leases the computer to you (the lessor) collects a monthly payment that includes a money factor (think of it as interest), as well a monthly charge for the depreciation of the equipment, and taxes on that amount if they are applicable. At the end of the lease term, there is usually a nondepreciated balance left on the equipment, which is known as the residual value. The lessor takes the equipment back from you and can resell the computer to someone else and recover its investment (of course, the lessor also takes the risk of a loss if it can't sell the equipment for the residual value.)

Cash Flow

For most small businesses, cash is king, and one of the major arguments in favor of leasing vs. buying is almost always the boost that leasing gives to your company's cash flow. You make monthly lease payments on equipment that you are using to generate revenue. Instead of investing a larger amount of cash up front to purchase infrastructure, you can use the extra cash for other purposes.

The negative side of this scenario is that, although there can be cash flow and tax benefits to leasing that may make it more attractive than buying, you are actually paying quite a bit more over time. There are also other less obvious costs that need to be factored in before you make the decision to adopt one alternative over the other.

A fair market value lease, or true lease, may give you the ability to fully deduct your monthly lease payment as an operating expense. This can be advantageous because the equipment write-down is linked to the lease term. If the lease term is shorter than the IRS depreciation schedules, you may have the potential for larger annual tax deductions. The deduction is also the same every year, which simplifies budgeting.

Compare buying a $5,000 computer to leasing it. If you purchase the computer outright, you have a capital charge that you can depreciate over the expected life of the equipment. If you have a capital outlay of $5,000 and you depreciate it over five years, essentially you have the right to deduct $1,000 of the capital expense from your taxes until the computer is fully depreciated.

If you lease the same computer for three years at a monthly lease cost of about $168, you may be able to write off $2,016 for each of the three years of the lease. You are paying more, but you get a larger write-off with the added advantage of being able to use your cash for other priorities.

If you finance the same computer for 36 months, your payments would be about $192 per month, but you can't deduct the whole payment as an expense because you are taking the depreciation charge over the life of the asset. Note that both the lease and the loan result in you paying more than if you had paid cash; additionally, the financing is about 14% more monthly than the lease.

You should consult a tax advisor to see if these scenarios are applicable to your company's situation.

Leasing gives you the ability to manage your technology budget in a couple of ways. Your monthly and annual technology costs stay relatively constant, and you avoid having to make a large capital purchase every few years. Leasing also gives you the ability to get more equipment for your technology dollar. Using the examples above, if you need $50,000 worth of equipment, your lease payment would be about $1,650 monthly, instead of the large initial cost. There are several comparison calculators available at a number of Web sites, including www.dell.com, that can help you with this analysis

Just about anything you can buy you can lease for your small business from the phones to the printers, fax, and cubicles. You can even lease the artwork if you want.

If you purchase computer equipment, you have to record the transaction as part of your balance sheet. You will either increase debt or decrease cash as part of the entry, with the potential of changing your financial ratios at the same time. You then write off the depreciation of the equipment over a period of years. With a true lease, you don't make a balance sheet entry at all; you simply make the entry to your income statement as an operating expense.



Long-term Purchase vs. Short-term Lease

How long do you plan to keep the equipment? Is it a quickly depreciating notebook computer, or is it some stable technology that you are going to keep for a longer time, such as a phone system or a major server? The answer to this question can be key to the decision to buy or lease.

At the end of the lease term, you will need to replace the equipment that you had leased in one way or another. Most leases give you the opportunity to buy out equipment at the end of the lease term for the amount of the residual, and most companies will give you favorable terms on new equipment at the end of the term, as well. If you buy your leased equipment, you will have paid substantially more for it in the end than if you had purchased it in the first place, because you will have paid both the ongoing lease costs, including taxes and insurance, as well as buying out the residual and paying additional tax on that amount, as well. Because the residual is usually far less than the value of the equipment at that point, this may not be a great bargain. In general, if you think you are going to keep something for a long time, you should consider a purchase. If you think you will keep the equipment for only a couple of years, leasing can often be the best alternative.

Nonfinancial Considerations

Leases can be much more complicated than financing or purchasing. Contract terms are not always clear to the average person. Make sure that you fully understand what your rights and responsibilities are, as well as those of the lessor. You should know if the computers are covered under warranty as long as they are under the lease. Is there a service plan built in to the lease, or is it available only for an extra charge?

Many leases give you the option to upgrade equipment at any time during the term of the lease. The lessor, especially if it is also a manufacturer, wants to make the relationship as easy as possible for you in order to encourage repeat business. Often lesser will make a master lease available that essentially lets you replace and upgrade equipment as often as you like.

You will want to know if the leasing company offers support services, installation, and upgrades as an option in your lease package. Although this adds to the overall lease cost, you may be able to reduce expenses if you don't need to hire full-time support staff. If you are going to rely on those services, though, you should understand the company's policy on site visits and phone support. Be certain that the company providing the support will be available when you need them, or your economy may turn out to be false.

If you are planning to replace equipment on a regular schedule anyway, leasing reduces your cost of disposing of the obsolete equipment. At the end of a typical three-year lease term, the computer has minimal market value, and selling off PCs may not be the best way for you to spend your time. Most schools and nonprofit organizations no longer accept older computers as donations, and throwing the computer in the trash is not an option. Depending on the size of your company, you may be able to redirect older equipment to users with lesser level needs, but if that isn't appropriate, you will want to get rid of the equipment somehow.

Disposing of obsolete computer equipment has become a major head-ache for many companies. Computer monitors and CPUs are full of toxic substances, and federal and state regulations are strictly enforced to make sure that heavy metals and toxic chemicals don't make their way into landfills. There are companies that will recycle used computer equipment for you, but recycling comes with a hefty charge that is not usually in the original budget. If you bought it, you own it, and disposal is your problem. On the other hand, under a lease you typically have no responsibility other than to return the equipment to the lessor, who assumes the responsibility for disposal, recycling, or reselling the computers. Make sure that equipment disposal is covered in your lease contract.


Asset Management & Maintenance

In most businesses, computer equipment gets moved around from place to place. It can be a very time-consuming task to try to keep track of where each piece of equipment is. Leasing companies often provide their customers with tracking software that makes it easier to know the location of the computers and their components at any given time.

It is very common for a technology leasing company to offer you the option to upgrade your equipment at any time during the term of the lease. This usually adds to the cost of the lease, but it can also be a convenient hedge against the risk of obsolescence in a rapidly changing technology environment. The advantage of this is that your costs don't go up directly. You just swap one piece of equipment for another, usually at the same payment. Of course, your term is going to be extended, and you never own the equipment, but you have the equipment that best suits your needs without a large capital outlay.

If you own the equipment and plan to keep it, the only expense is the cost of the upgrade. However, you will need to have someone available to install the upgrade, reconfigure the machine, and get the user back up and running.

Startups

If your company is a startup, the cash flow problems are usually magnified over those of an established company that is trying to grow. If you have raised capital from investors, you are going to be very careful to make sure you get the maximum advantage from every dollar. Should you lease or should you buy?

The decision points are about the same, but the need to conserve capital is always greater. Making large investments to build infrastructure before a steady stream of sales begins is not usually the most efficient use of funds for a startup. Leasing gives your startup the highest possible leverage on your capital and lets you invest any extra in research, marketing, and sales. Leasing is almost always the best way to go for a startup.

Manufacturers want to sell their equipment, so they are often willing to arrange a lease if it makes the difference between making the sale and losing the sale. There may be a requirement to have one or more of the principals of the company provide a guarantee based on personal credit and assets, but many startups have had success building a business based on leased equipment.

by Bert Nixon