Rent, Lease or Buy
What happens when you are told that your company’s existing bank lines are insufficient? What if your company cannot qualify for bank financing due to current economic conditions? The answer may be a capital lease or rental of the equipment.
Making a Business Case for Lab Equipment Financing
With Pittcon approaching, acquiring new equipment is on the agenda for many laboratories. The economic crisis has made finding capital for these purchases extremely challenging. Large companies are freezing budgets, banks are making borrowing more difficult and everyone is trying to get the most out of the equipment they already have.
Let’s assume your company has signed several contracts in 2010, and you need new instrumentation to meet the increased demand, or you can no longer delay replacing existing worn or obsolete instruments. Normally, the next step would be to issue a purchase order and pay cash for the units. Is this your only option?
What happens when you are told “There is no capital budget available for the purchase” or that your company’s existing bank lines are insufficient? What is the solution if your company is no longer profitable and cannot qualify for bank financing due to current economic conditions? Finally, what if your company is new in business or venture backed without revenue? The answer may be a capital lease or rental of the equipment.
Financing has been used for thousands of years. Archeologists have found finance agreements etched into clay tablets dating to 2000 BC. Evidence of equipment financing has also been found in the historically relevant empires of Babylon, Greece, Rome and Egypt. Fast forward to 2011: equipment financing has become a valued way of acquiring equipment for all businesses. Business owners agree that equipment financing is the best way to acquire equipment that may become obsolete or increase overhead costs. As a matter of fact, about 80 percent of large and small businesses in the U.S. use equipment financing to fund their operations.
Let’s take a look at:
- When to consider financing for laboratories in very large companies, labs in small to mid-size companies and, finally, labs in newer businesses or those that are pre-revenue or venture backed.
- The basic financing types to consider.
- How to choose the right finance provider.
When to consider financing
No other axiom rings truer today than “If it appreciates— buy it; if it depreciates—lease it.” Of course, with today’s changing tax laws and seemingly endless advancements in technology, there can be other factors driving this decision besides the fact that the instrument is a depreciating asset. Let’s examine a few of the more common scenarios:
1. Laboratories in large companies
Let’s consider a large company with multiple facilities that has either exhausted or frozen its capital budgets. When one of the labs needs additional instrumentation, they are told to wait until the next budget cycle, meaning the acquisition is delayed for what could be a very long time. Does this mean there are no other alternatives? Not necessarily, as there are rental agreements available that allow for payment through expense budgets until the capital budget is available. A well-written rental agreement will provide the option of purchasing the rented instrument by allowing a large portion of payments made to be applied toward the original purchase price anytime during the contract. This means that if you have room in your expense budget, you are able to acquire the instrument you need now even though you are told there is no capital budget available. Best of all, you also have the ability to purchase the instrument whenever your budget is approved.
2. Laboratories in small to mid-size companies
Let’s consider the lab in a smaller company that does not operate under capital budget constraints, but has issues with either utilizing its existing bank credit or, because business has been slow due to economic conditions, cannot qualify for bank financing.
Equipment finance companies are easier to work with and more flexible than a bank. They can offer various structures for smaller labs in established companies, regardless of their credit profile. Labs of this size are looking for financing that allows for ownership of the instrument over a fixed period with a fixed payment. This can be accomplished through a lease contract that provides for a small purchase option (usually $1) at the end of the lease.
When utilizing this type of lease contract, you can often bundle most of the soft costs involved in the acquisition into the contract. For instance, shipping, training, installation, software and even an initial supply of consumables may be bundled into the amount you can finance.
3. Start-up companies/laboratories that may be prerevenue or venture backed
Finally, let’s consider laboratories in companies that would not qualify for financing from banks or traditional finance companies. Normally, the only option for companies such as these is a cash purchase. There is an alternative as there are finance companies that specialize in more difficult credit situations and/or in financing scientific instrumentation that may offer partial financing for needed instrumentation. These companies allow for the preservation of the precious capital raised to fund the operation until the company is self-sufficient. Finding a company like this can be vital to the overall achievement of your company’s financial strategy, which is why we emphasize selecting the proper finance company.
Basic equipment financing types
Let’s take a look at three common methods of equipment financing being used today.
1. Capital or finance lease – Under this financing contract, the lessee (the party making payments on the asset) owns the equipment at the end of the agreed-upon term for a bargain purchase price, which is usually $1. The term, interest rate and payment are fixed. It is the preferred method of lease financing for labs in smaller to mid-size companies as it is similar to a bank loan, but much easier to obtain.
The lease appears on the balance sheet as an asset. The interest portion of the lease is tax deductible as well as the depreciation associated with the asset.
A substantial benefit to this type of lease structure is that The Small Business Jobs & Credit Act of 2010 allows for the potential deduction of the entire cost of the instrument, assuming it is placed in service by the end of 2011, through Section 179 of the IRS code. The benefit begins to phase out after $2.5M worth of equipment purchases in 2011.
2. Operating or FMV (fair market value) lease – Under this financing contract, the Lessee makes payments for a fixed time period and has the option to purchase the asset at the end of the contract term at its current fair market value. This structure is sometimes used by laboratories in large companies that do not have capital budget available. Generally, the payments on this type of contract are treated as an expense and do not appear on your company’s balance sheet.
This structure has a couple of weaknesses when compared with a well-written rental contract. The first is that the asset cannot be purchased until the end of the lease term, which means that, if budget becomes available prior to the end of the term, all payments applicable to the initial term must be made prior to purchasing the asset. Second, there is no cost certainty since the fair market value purchase option at lease end is an undefined amount; the finance company’s interests and those of your company may be at direct odds as the finance company will want the highest possible price for the asset.
3. Rental contract – A well-written rental contract provides for fixed payments for the initial term of the contract, but allows for the purchase of the asset AT ANY TIME during the term, with application of a high fixed percentage of payments made going toward purchase. This structure is often used by laboratories in large companies that do not have capital budget available. Generally, the payments on this type of contract are treated as an expense and do not appear on your company’s balance sheet. It is preferable to the fair market value purchase option since you may purchase the asset AT ANY TIME during the initial term; you also have cost certainty when purchasing the asset as the percentage of each payment applied to said purchase is provided at the time the contract is signed.
Please check with your tax advisor to ensure that you have a full and accurate understanding of the tax and accounting implications of any financing agreement you may enter into.
How to choose the right finance provider
There are several very important points in choosing an equipment finance company.
1. Seek out a finance company that has experience financing scientific instrumentation to laboratories on a regular basis. Companies with this experience can understand and work with your business, regardless of your company’s credit profile, size or time in business.
2. Is the finance company willing to act as a financial consultant to your company, or are they just interested in making a deal? Take note of the representative’s willingness to understand your situation and his/her level of service. How knowledgeable is the representative? Do the representative’s answers to your questions inspire your confidence in his/her ability to help you select the best option for your situation? Are the company’s offerings based on your needs?
3. Is the leasing company also part of the manufacturer? Many times the company providing the equipment or service will have a partner finance company that will handle the leasing. Many vendors have gone through a vetting process and have selected the finance partner because they have the same goals and values. Rest assured that this is a good company to work with.
4. Check references on the finance company. Ask the finance company for references for recently completed transactions. Check the Better Business Bureau for a rating and see if there is any negative feedback. Usually, a leasing company will be a member of a leading industry association.
5. How quickly can they give you an approval and lease documents. Once you select the instrument you want, you expect to receive it in a timely fashion. The same applies to finance companies. Ask them what their anticipated response time is regarding both approval and documentation preparation. This should be done expeditiously, thus making your equipment acquisition quick and easy.
Making a choice
Equipment financing can be an invaluable tool to help your company grow and acquire the instrumentation needed to fuel that growth. In the past, your laboratory may have only considered purchasing instruments. It is my hope and the intention of this article to offer viable alternatives to purchase that may allow you to acquire what you need today rather than delaying a much-needed acquisition.