Every year, thousands of business owners and financial managers are faced with the task of obtaining attractive financing for equipment their firms want to acquire. Snaring the best leasing arrangement requires only a bit of planning and a smidgeon of finesse. You can save time, land a better lease deal and make the leasing experience less of a conundrum by considering several important factors.
Plan Ahead
Before seeking lease proposals, invest a little time in planning and preparing. Establish priorities by considering the relative importance of such factors as lease pricing, balance sheet considerations, ongoing leasing needs and the necessity of the prospective lessor to have specialized equipment/industry knowledge. If the transaction is relatively insignificant in the overall scheme of things, a truncated planning process might be in order. If not, allow enough time to: 1) identify and pre-qualify lessors, 2) review and select a lease proposal, 3) allow selected lessor to conduct due diligence and get credit approval, and 4) to complete lease documentation.
Assemble an information package for prospective lessors that anticipates what they will want to know before submitting a proposal, including: 1) background information on your company and management bios, 2) three years of financial statements and interim financials, 3) a list of company trade and credit references, and 4) a description of the equipment to be acquired, including acquisition cost. Anticipate questions about your firm and disclose them in advance.
Choose the Right Leasing Company
The starting point for getting an attractive leasing proposal is in choosing the right leasing companies to bid. All leasing companies are not alike. Some specialize in specific industries, some in certain equipment types, and still others in transaction sizes. Leasing companies also vary in size, capabilities, expertise and integrity. Do your homework to pre-qualify leasing companies that will bid. Lessor qualities to look for include: 1) knowledge; 2) reputation; 3) ability to perform; 4) helpful business contacts; and 5) a relationship approach. Try to identify at least three leasing companies to bid.
As in any field, leasing professionals have varying degrees of knowledge and expertise. Look for leasing representatives and managements that have a good understanding of lease structuring, equipment issues, documentation, credit evaluation, the capabilities of their firms, your industry and other leasing issues. Avoid lease ‘sellers’ with obvious limited knowledge. It is too easy to be led down the painful path of misinformation and misrepresentation.
Because the entry bar for setting up shop in equipment leasing is relatively low, it is important to locate leasing companies that have good reputations in the business. Check to see whether the bidding leasing companies belong to one or more of the major industry trade associations (e.g. ELA, EAEL, UAEL, and NAELB). While membership in these associations doesn’t guarantee high ethical standards, each of these organizations has standards and processes to review members’ unethical business practices. Contact relevant associations for references. Then, get several names of customers, banks and vendors to contact.
Along with good ethics, the ability to perform as agreed is equally important in considering leasing partners. Ask for and get financial information, background information on the key managers, a listing of recently completed financings, names and contacts at key funding sources for each leasing company being considered. Review this information and follow up with the contacts provided. If your industry and/or the equipment to be leased are highly specialized, make sure the leasing companies have completed several arrangements similar to the one you are seeking. Check lessors’ websites and brochures to make sure that the type of leasing arrangement you are seeking is specifically referenced and discussed.
Good leasing partners offer more than equipment financing. In many cases, lessors have met or worked closely with bankers, attorneys, CPA firms, business insurers, equipment vendors and investors. If the leasing company serves a wide variety of customers, some of these contacts can prove invaluable. Try to get a feel for the depth and breadth of each leasing company’s ability in this area.
Since you will be working closely with the selected leasing company and may have additional leasing needs in the future, why not choose a leasing partner that values relationships? Although it is not easy to identify relationship-oriented leasing companies at the quoting stage, check customer references to inquire about lessor follow-up, attentiveness, willingness to learn about customers and willingness to be helpful.
Get a Large Enough Lease Facility
Right-sizing the leasing facility can save a lot of time. Look for an arrangement that will cover equipment needs for at least the next six to twelve months. A helpful rule of thumb is to obtain a leasing facility that is at least 20% more than what is needed. If a leasing credit line is an available option, this can be a helpful tool in securing the right amount of lease financing.
Choose a Lease Term That Matches Equipment Use
The term of the lease should match the expected use of the equipment as closely as possible. If the term is too short, the monthly cash outlays for the equipment might exceed the expected benefits to be derived from the equipment (cost savings or revenue production). If you sign a lease that is too short that also includes fair market value end-of-lease options, and you exercise one of these options, you might wind up overpaying for the equipment. If the lease term is too long, you might lose the flexibility of upgrading to newer more desirable equipment. More than a few lessees have been stuck with equipment they no longer need, yet they still have a significant lease balance remaining.
Notwithstanding your preference, a shorter lease term returns the lessor’s investment in the equipment faster and lessors generally perceive a faster recovery to be a credit enhancement. You might be able to manage any mismatch between your preference and the lessor’s by obtaining favorable end-of-lease options. Seek end-of-lease options that include: 1) the right to return the equipment to the lessor; 2) favorable renewal options; and 3) favorable purchase options. Seek ways to limit what you are charged by requesting fair market value options that are “capped” (have upper limits) or favorable fixed options.
Look For Lease Flexibility
Obtaining lease flexibility can easily trump obtaining the lowest price. In fact, you can trim lots of money from overall leasing costs by having a flexible leasing arrangement.
First, make sure the lease allows you to include most of the equipment you intend to acquire. Also, check that it will be easy to add more equipment to the lease as your needs change. The better leases provide for multiple schedules under a master lease or the ability to amend existing leases to make additions. What if you no longer need some of the equipment? An early termination formula is useful in these situations. Generally, these formulas consist of present valuing the remaining rents. If the equipment has a strong residual value, try to negotiate a more favorable termination charge by incorporating some of the anticipated residual value.
A flexible lease arrangement anticipates upgrades. Usually, at the time of equipment upgrade, the present value of rents associated with the upgrade can be combined with the present value of the remaining equipment rents to create a revised schedule. Other methods might be required in the event that the lessor will incur penalties or additional charges resulting from the way the lessor has funded the lease.
Will you be able to terminate the lease early without an onerous charge? An amount consisting of the present value of the remaining rents plus a termination charge no greater than 3% to 5% should compensate the lessor for early termination in most leasing arrangements. Where equipment has high residual value, request that a portion of the anticipated residual value be applied to reduce early termination charges.
Does the lease have flexible end-of-lease options? Clearly, if the lease contains a nominal purchase option, there is little need for additional end-of-lease flexibility. Otherwise, a good array of end-of-lease options is desirable. Request the right to return the equipment to the lessor without undue penalty or expense, the right to purchase the equipment at a fair or reduced price, and the right to continue leasing the equipment at a fair or reduced rent. Use of ‘caps’ in fair market value purchase or rental options can greatly reduce potential costs at lease end. Beware, however. Lessors may insist on fair market value ‘floors’ (lower limit) when they agree to ‘caps’.
It may become necessary to relocate the equipment to another site. Make sure the lease provides that equipment can be relocated without unreasonable penalties or charges, subject to notifying the lessor. Keep in mind that equipment relocation may create extra expense for the lessor, particularly if it is to be moved to another state or to multiple locations. Most lessors perceive multiple locations as adding additional risk to the transaction in the event they must repossess the equipment. As long as these considerations are taken into account, the lessor should permit relocation of equipment with reasonable notice and reimbursement of lessor’s direct costs and administrative expenses.
Is there a sufficient notice period at the end-of-lease for you to indicate your desire to renew the lease, purchase the equipment or return the equipment? The notice period generally ranges from one to six months, with three months being typical. If you violate the notice period, the lease kicks into an automatic renewal period, usually one to six months. You should seek notice and automatic renewal periods that are short, to avoid unintended additional lease charges. If the lessor is unwilling to negotiate this provision, you can manage the situation by making sure the notice requirement is fulfilled within the allowed time.
Look For Competitive Lease Pricing
Lease pricing is a function of many factors, including: market rates, perceived lessee credit risk, lessor competition, equipment collateral quality and equipment re-marketing prospects. Get at least three lease bids, if possible. At the end of the day, lease pricing is market driven. A properly completed present value analysis will bring into focus comparison of diverse proposals otherwise difficult to make. Make assumptions about the equipment residuals and incorporate all anticipated costs and fees. Take into account the amount and timing of the periodic rental payments, any advance rental payments, security deposits, cash collateral, interim rents and commitment fees. To achieve an accurate analysis of cash flows, you should incorporate any tax charges/benefits as they are to be realized.
If you are concerned about the impact of the lease transaction on your firm’s financial statements, compare the impact of each proposed lease on the balance sheet and income statement (if lease accounting is not your forte, get a qualified accountant involved). For example, if your company is sensitive to adding additional debt to its balance sheet, a capital lease should probably be avoided. As you can see, there are several ways to evaluate lease proposals and to compare lease pricing. The important thing is to use an analysis method with consistency and to choose the method that best fits your company’s priorities.
Understand All Fees and Penalties
Leasing proposals vary in the types and amounts of fees and penalty charges. Some common lease charges include: commitment fees; documentation charges; charges for attorney fees; and charges for UCC financing statements. Additionally, some leases might contain penalty charges for late rental payments or early lease termination. These are only a few of the possible fees and charges. It is important that you go through the lease proposal and lease agreement to identify likely charges. If fees or charges are significant and likely, you should incorporate them into your pricing analysis.
Understand the Lessee’s Major Responsibilities and Obligations
Most lease proposals cover the basic terms of the lease, but are silent regarding many of the obligations and conditions normally included in the lease agreement. Lessors usually will not negotiate the lease agreement before receiving a signed proposal letter. While negotiating lease terms might not be customary or practical at the proposal stage, requesting a copy of the lessor’s standard lease along with the proposal letter is a good idea. In their standard agreement, look for any onerous or non-standard terms that would otherwise eliminate the proposal from consideration.
There are lease provisions that are common to almost all ‘net’ lease agreements, including: 1) prompt payment of rent, taxes and other required payments; 2) equipment & liability insurance; 3) equipment maintenance and upkeep; 4) tracking and reporting relocation of equipment; 5) freedom from any liens or other encumbrances against the equipment; and 6) return of equipment. Less common lease provisions, such as financial covenants or requiring personal guarantees might not be competitive or might result in you rejecting a proposal that is otherwise attractive. Review the proposal letter and the lessor’s standard lease agreement to insure that they are free of provisions that are problematic.
In all cases, it is important that you have the right to terminate the proposed transaction if you and the lessor can not come to terms on the lease agreement, especially if onerous terms appear in the lease that are not covered in the lease proposal.
Conclusion
Snaring the best lease deal and relationship need not be like getting a root canal. With a dash of advance planning and a few well defined objectives, you can find a good match. Remember to establish your priorities in making a decision on lease proposals and allow enough time to go through the proposal, lease approval and documentation phases. Also, while lease pricing is usually of utmost concern, make sure you consider other factors that can increase costs or create problems.
