Realities and details in leasing gear

Suppose we all had a money tree. What a splendid garden it would be, carefully tending our trees, pruning each branch.

Spring brings that first sign of new life; we’ll call it loose change. That makes a person feel good – there’s hope for vast rewards. Summer – ah summer – shows us the bold green color of our hard-earned bounty.

Then, glorious autumn. With each dollar in full maturity dropping on the yard, our treasured money tree is giving us the pleasure of literally raking in the dough. (And I don’t want to talk about winter!)

Of course, there is no money tree. Rather, we all deal with a little thing called REALITY when it comes to commerce. Yet even in this less-exciting version of the universe, there are ways of making your financial gardens grow and bloom.

IN PLAIN ENGLISH

Leasing equipment, rather than buying, can present the potential for positive progress. In my discussions with vendors and customers, I find some who are all for leasing, while others can’t see how it fits into their plans. How about a look at “Leasing 101” to get a better understanding”

The best place to start is with a definition in plain English. An equipment lease is simply a contract between a lessor (the company providing the lease) and a lessee (the end user). The lessor rents products to the lessee for a mutually agreed-upon period of time and specific rate of pay. The two parties also agree to a purchase option for the equipment, or it is returned at the completion of the agreement.

In the U.S., there are two basic types of equipment leases offered for general business equipment. (The IRS defines other types of leases, but in the majority of cases, we’re talking about the “big two.”)

One option is the Capital Lease, very similar to an installment bank loan, and, like loans, they are treated as purchases. At the end of the term, the lessee (that’s you!) takes an ownership position. The assets of a Capital Lease appear on your balance sheet, with the equipment included on the depreciation schedule rather than treating it as a line item expense.

Recent tax code incentives, such as the 50 percent depreciation bonus, plays very well come tax payment time. And note that a Capital Lease is an interest-bearing note, so the interest on the lease can be classified as an expense.

On the other hand, there is the True Lease. Let’s say that you and your accountant (because you should be talking with your accountant!) have agreed it’s better to treat your lease as a rental agreement.

A True Lease can be carried off your balance sheet and listed as a line item deduction. Note, however, that these payments are NOT interest bearing! The payments are 100 percent written off against pre-tax dollars, minimizing your taxable income.

Like any other tax break, there are rules, so don’t get misled into thinking that a pre-set buyout, for example, 10 percent, is going to qualify you for this program. If this lease is treated as a purchase in any way, then it’s not a True Lease. As a result, my advice is not to tango with the IRS. Or get anywhere near them, for that matter. (See July/August 2000 issue of Live Sound for more information on these rules.)

It’s always been my position that large-ticket items typically leased by live sound professionals should be capitalized. After all, ownership is usually the long-term plan of action, isn’t it?

And remember this very important rule: when capitalizing a lease, be sure to have – in writing – the exact purchase option whether it be $1, $1000 or 10 percent. I’ve heard so many horror stories about end-of-lease disasters. In fact, some really well-run businesses won’t touch leasing because of this very thing.

EASIEST METHOD

Most leasing companies offer “application-only” financing arrangements, probably the easiest method of making purchases. You don’t have to experience that sinking feeling of inferiority associated with being “short-chaired” by a bank. (Reference the film It’s A Wonderful Life.) A mid- to upper-level five-figure loan can be attained by providing basic company information on the application.

A few basic qualifiers:

1. Time in business. Two years (or more) typically opens the door.
2. Bank and trade references. The lessor looks for an average of at least $1,000 in your business bank account. Don’t list vendors you’re not paying on time – it doesn’t make sense.
3. Personal credit of all owners. Ah yes, the sensitive issue of personal credit. In today’s wacky economy, it’s wise to tend to your creditors. In my view, this is the single most valuable asset to your businesses.

A few other factors, more minor in nature, are involved, such as Dun & Bradsteet reports and knowing the age of the equipment to be leased if it’s used. But for the most part, this is all that’s required to be in the running for an application-only lease.

When faced with a purchase larger than the parameters of the application-only lease, the financing of the equipment must be viewed similarly to approaching a bank. Most lessors request a full financial package, consisting of business and personal taxes as well as financial statements.

Also, many lessors are cash-flow lenders. If your statements verify adequate cash-flow coverage along with a reasonable net worth in accordance with the amount of money you’re applying for, you’ll likely qualify.

A little trick to beef up net worth when it’s not obvious on your financial statement is to have a reputable appraisal firm draw up a current inventory with the street value of your unencumbered assets. This shows the lender that you care about their equity position, while also demonstrating that your company is liquid. It’s helped some of my customers get large-ticket leases even thought their statements didn’t merit the approval.

When dealing with leases at this level, expect a discount in rates and more flexibility in terms. Rates can drop simply because you’re proving to the lender that you’re minimizing their risk. Terms can be flexible for the same reason.

Finally, select the right leasing company to work with. It largely comes down to comfort and fit, in addition, of course, to the lease being fair and well presented. It’s like going to the barbershop. If you’re not sure about the steadiness of Floyd’s hands, you’re not comfy in the chair, right?

Feel out the lessor, see if there’s any real care as to whether you make out well with this investment. After all, they’re being paid to handle your investment, and this directly affects your livelihood.

No deal is perfect, so get a sense that the leasing company is going to be there for you after the deal is booked. You shouldn’t feel left out in the cold. And keep dreaming about money trees!

Originally published in Live Sound International – March 2004 – Volume 13 Number 3

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The Fiscally Forward Path of Leasing

Congratulations, you’ve survived another cold winter and now, you’re geared up for the ever so active summer months. Fairs, festivals, and maybe even tours are on your palette.

But how do you plan to fortify your rig to meet those riders? Sub-rental? Talk about lost wages. Pay-as-you-go? I don’t know how that’s going to help by cutting your cash reserves down to the bone.

How about leasing?

It seems to be fairly popular. I for one am obviously a big fan! Historically, bankers and other commercial lenders have viewed the concert production industry as generically high-risk. Lessors, on the other hand, tend to look at things more liberally and have a more hands-on approach to lending.

If leasing is the route you choose to take, here’s some advice to help you get started. There are typically three parties in a lease transaction: the lessor (me), the lessee (you), and the vendor. When first inquiring about leasing, call your vendors and others in the business which have already tried equipment financing.

They’ll be glad to give it to you straight on how the lease has worked out for them. When searching for the proper leasing company for you, seek those already familiar with Performance Audio. Their experience should prove useful and timesaving. Of course, make sure they know leasing too. That’s important.

Applying for Approval

Once you have chosen your lease company, you can start thinking about your approval. The qualifying factors are usually standard throughout the industry. Depending on the size of the transaction, many leasing companies offer “application only” financing.

Typically, the amount of time you’ve been in business, as well as your personal, credit determine the outcome of the application. Once approved, leasing can allow you the ability to purchase equipment that would have been unaffordable with day-to-day cash flow.

Next, let’s examine leasing in technical terms. We often hear horror stories about how a company went into a lease thinking one thing, and ended up getting another. The types of leases you should be familiar with are Operational and Financial Leases.

Operational Leasing

Operational Leasing is best described as a rental agreement over a very short term, where the end user (lessee) rents the goods without any intention of ownership. You’re most likely familiar with this type of lease when it comes to truck and large frame mixing console rental. This can become quite expensive if long-term use is considered.

Financial Leasing

Financial Leasing offers a payment plan generally covering 100% of the equipment cost. The term is usually non-cancelable, and in some cases carries a penalty for early payoff. The payments are fixed, and fluctuate in rate, depending on term and lease structure.

The financial lease plan can be further broken down into tow sub categories or lease structures: Operating Lease and Capital Lease. Both are similar in form, but must be treated differently for accounting and tax purposes.

A Capital Lease is a conditional sales contract or purchase agreement. The intention is ownership by the lessee at the end of the lease term. Typically, Capital Leases are written $1.00 purchase option.

Be aware that if you predetermine the end of lease option, even if it is greater than $1.00, you may be required to capitalize the lease. It’s a common misconception that 10% buyouts are always fully tax deductible. Not so when 10% is a bargain purchase, and you intend to make the purchase going into the lease.

A bargain purchase is a buy out that’s less than the actual market value of the goods at the time of sale. Items on a Capital Lease are to be carried on the balance sheet as an asset. The equipment cost is depreciated and the interest expense is amortized – very much like a secured loan.

You would most likely consider this form of a lease when acquiring large ticket items such as consoles, loudspeaker rigs, roofs and decking. These items usually have an anticipated shelf life beyond the term of your lease.

Tax Benefits

When leasing for tax benefits and off balance sheet accounting, you’re looking to write a True (tax) Lease or an Operating Lease. These two lease structures are similar in that they require no pre-determined purchase option. To qualify under certain rulings, they should be written with a fair market value buy out.

Operating Leases are designed to improve your balance sheet, and the lease rental payments are reported as a line item expense on your P&L or income statement.

An operating Lease is defined by what is known as FASB-13. This is a statement issued in 1976 by the Financial Accounting Standards Board.

Basically, FASB requires the lessor and the lessee to share in the equity position of the asset until the rental term is complete. Rarely are you going to be involved in an Operating Lease primarily due to the equity position required of the lessor.

True Leases

On the other hand, True Leases are very common as long as we follow the rules set forth by good old Uncle Sam. In 1955, the IRS issued Revenue Ruling 55-540 to distinguish between True Leases and Capital Leases. A lease qualifies as a True Lease only if NONE of the following factors exist:

–        Lessee applies any part of the rental payment to an equity position in the equipment.

–        Title to the equipment automatically passes to the lessee upon payment of a stated amount of mandatory rental payments.

–        Total rental payments for a relatively short term constituted an inordinately large percent of the equipment cost.

–        Rental payments materially exceed the current fair rental value.

–        Lessee has a nominal purchase option at lease end.

–        Some portion of the rental payment is designated as interest.

True Lease = Rental Agreement

The True Lease option is basically a rental agreement. You use the equipment for a specified period and either return it to the lessor, continue to rent on a monthly basis, or purchase the equipment at a fair market value. Keep in mind that with a True Lease you’ll have a lower monthly payment. This will offset the cost of a fair market value buy out.

When negotiating with your lessor, try to compare the cost of a Capital Lease to a True Lease dollar for dollar. If you can keep the cost relatively equal, the tax write off of a True Lease could prevail as a better deal. Be sure to anticipate the fair market value being greater than 10% of the original invoice amount.

The fair market value issue is often a tough subject when leasing durable goods such as consoles. Let’s face it, if I lease you a new Midas H-3 at about $70,000.00 and in three years tell you that I want $40,000.00 for my buy out, you’ll be less then thrilled. What do we do? For tax purposes, we have to follow these guidelines. How do we get around that issue and still take the tax write off?

We, as lessors, can only recommend that you consult your accountant. This is not a cop out! It’s unfair for me to be your tax advisor when I assume no liability if my advice is wrong. Some accountants are more aggressive than others, and they’re willing to look at all of our leases, no matter what the purchase option is, as True Leases. Unless the lease contract you sign speaks of a purchase option, it’s in fact a true lease document.

Hold This Thought

As a Performance Audio professional, there is a basic rule of thumb that you should consider when kicking around the lease option. Over the past few years, I’ve found myself writing Capital Leases for items kept in inventory for long periods of time like consoles, cabinets, trussing and decks. Computer-based equipment and other products with a short shelf life are more commonly written as a True Lease. Common sense should lead you into making the right decision.

With the rising cost of equipment and the tightening of our current economy, more companies will rely on the services of the leasing industry. Being better informed, as well as strategically planning your purchases through leasing, can prove to be a lucrative investment.

With the application-only programs and the involvement of our staff in your industry, we lessors can provide the most comprehensive financial services available. Our job is to help you because we know that the show must go on!

Originally published in Live Sound International – July/August 2000 – Volume 9 Number 4

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An Overview of Equipment Acquisition Options

No matter how you slice it, economics is a tedious component of any business. When acquiring equipment you’re faced with various options that leave you wondering what is best for your company.

Many questions must be answered such as: When is it best to pay cash? Who should I bank with? What is leasing? and Where is Uncle Guido’s number? They may begin to overwhelm you. While these are all viable options, there are pros and cons that must be considered for each.

Cash, an Interesting Topic

We all want it, and if we have it, we want to keep it. It’s considered the most inexpensive means of acquiring goods. But is it? Many of us believe that cash is king without ever thinking of the opportunity costs. In such a case the cost is not charged to you, but may be lost anyway.

Cash is among the strongest assets and can allow you to grow your business at a pace that you feel comfortable. It can also be viewed as a safe haven. In the concert production business, there is an absolute truth. Without cash, rainy days are far harder to weather.

Rather than tying up your hard earned cash into equipment that quickly loses value, consider investing in real estate, the stock market, or even, heaven forbid, advertising. These are a few investments that have proven to be successful over time.

However it does make sense to set some cash aside for other concerns like personnel and maintenance. Preserving your cash reserves is undoubtedly a wise business decision. Cash is king – just don’t let the crown lose its luster.

Banking and Lending

When it comes to banking relationships, we all hope that ours is stable and secure. We can expect very competitive rates and a free coffee cup. But let’s not kid ourselves. Bankers are still bankers set out to protect their portfolio by taking minimal risks.

Performance Audio is, without doubt, viewed by most loan officers as a high-risk business. The only time I hear about a sound or lighting company being courted by their bank is if I’m dealing with a very old and/or large company, or if Mr. Loan Officer is someone’s brother-in-law. “Kudos for them.”

Let’s say you do have a friendly banker and he or she is ready and willing to give you a line of credit. Perfect, you’ve achieved a very important goal…the use of someone else’s money. The first thought should be how to best use those funds. If you use the line up for equipment purchases, are you cutting off your nose in spite of your face?

I mean, how are you going to make it through tough times without that extra cash set aside. Last I checked, money doesn’t grow on trees. That valuable line of credit can be used to cover incidental costs such as sub-rentals, add on personnel, and other unforeseen emergencies.

The Lease Option

Equipment leasing has been a consideration for many years by sound and lighting professionals. With its convenient approach to lending, the leasing industry puts larger dollar equipment into the users hands nearly as fast as old Uncle Guido. However, leasing does have its own set of pros and cons, and if you’re not prepared, you could be displeased with the whole leasing experience.

With convenience comes cost. Leasing can be viewed as opportunity cost, but it is an expense to the buyer just the same. Risk is the primary factor in the cost of doing a lease. Many leases are written without the need of financial statements, so as to allow the smaller to mid-sized companies the same opportunity of acquiring large dollar items as the big boys.

Leasing costs can vary based on the credit profile of the applicant and current economic trends. Use good common sense when negotiating lease payments. If your leasing agent pulls up in his or her new Viper, you should worry!!!

The Tax Advantage

Certain tax advantages also come along with leasing. Your leasing agent should have adequate knowledge of the different leasing tax laws. But remember, they’re salespeople. Don’t rely on their advice alone. It’s your accountant that has to sit through the audit with you.

Choose wisely when selecting a lease company. There are many firms that process leases like bumpers on a production line. The faster they get them out, the better off they are.

It may benefit you to look for a company that has some working knowledge of your industry. A leasing agent who focuses on niche markets, often understands the politics and language of your industry.

And let’s not forget Uncle Guido, for those who have one. The biggest draw back when borrowing from family can be the payback arrangements. No one wants to burn bridges with family – or be thrown off of one for that matter.

Financing is a necessary evil we all have to deal with. Common sense has always proven to be the most reliable approach to borrowing. Know your options and seek out advocates you can trust. It’s your hard earned money. Make it work best for you.

Originally published in Live Sound International – March/April 2000 – Volume 9 Number 2

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