Getting Gear When You Need It
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 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 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.
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.
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