Is Equipment Leasing a High-Risk Financial Service?
Corporate financial professionals love the predictability of equipment leasing. By leasing, the cost of the equipment can be can spread over a fixed period with set lease payments. By exchanging the relatively unpredictable cash flow of equipment ownership for fixed monthly lease costs, cash flow forecasting can be more reliable and more easily formulated. Lessees can also avoid the risks of equipment obsolescence, which is particularly acute in IT.
But companies are making a dangerous mistake if they consider equipment leasing a low-risk source of financing. Equipment leasing can be a high-risk financial service and when lease agreements are not structured properly, it’s common for lessees to pay 20-50% more than if they had purchased the equipment.
One of the principal ways in which lessors make money is end-of-lease revenue. Equipment leasing companies focus on creating leases that provide profit for them when the lease term expires.
If your company is entering into various forms of financing, including equipment leases, you need to appreciate the critical importance of reviewing a variety of end-of-lease terms and conditions to ensure that the terms don’t favor the lessor. Pay special attention to the terms defining “fair market value” to ensure that the contract language won’t leave you paying much more than expected at the end of the lease.
In addition to end-of-lease terms, you need to thoroughly analyze all aspects of lease agreements to identify potential risks and hidden costs.
For example, the potential cost of interim rent is often underappreciated and overlooked. Interim rent is paid for equipment from the time it’s delivered until the lease begins. If not contractually capped and monitored, interim rent can add material costs to a lease before it has even officially commenced.
Equipment leasing documents are typically prepared by lessors and presented as “standard.” But the “standardization” belies the fact that lease agreements are highly specialized contracts that deserve much more than the cursory review by your company’s financial services managers.