Over 80% of all U.S. companies lease all or part of their equipment (up from 64% in 1984) and the numbers go up when dealing with emerging companies and/or with high tech equipment.

Annual leasing volume in the U.S. alone is now over $230 billion a year meaning that almost 33% of all capital equipment is acquired under a lease contract.

Leasing is a powerful and flexible way to purchase your business equipment. 

Powerful because it makes it easy for you to acquire your equipment and flexible, because there are different kinds of leases, and a variety of structures.

Example:  Let us assume that we have a lease contract at a perceived interest rate of 14%.  It finances 110% of the equipment cost because it picks up delivery, installation, training and some initial supplies.

 It requires one month’s rent in advance.  There is a lien only against the specific equipment leased.  The leasing company will not bother you for the next five years as long as you make the payments as scheduled. 

At the end of that five-year period you can buy the equipment for its then current fair market value (which is minimal); and they will have fully expensed the lease payments for tax purposes.

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Alternatively, there can be a bank loan.  It is at 8.5% interest, but the customer is required to keep 30% of the loan amount in compensating balances in a non-interest bearing account at that bank (so the bank is really lending you 70% of the bank’s money).

 A computation of the real yield is over 25% APR (because the you are paying interest on 100%, but only getting 70%).  Using the same formula, a 20% compensating balance requirement yields almost 19% APR and a 10% compensating balance about 13.25% APR.

In addition to the requirement to leave part of the money in the bank, they also have covenants that require you to maintain certain financial rations. 

The bank has filed a blanket lien against all of your assets (“now and hereafter acquired”) and they are probably cross-collateralized by your kids’ trust accounts, personal account, and everything else in the bank.  Scary!

There is probably a clause in the loan agreement that says if at any time the bank feels uncomfortable with the industry you are in, they can call the loan – even if every single payment has been made on time.  There is probably another clause that says the loan rate will increase if the bank’s cost of money goes up.  (Our rates are Fixed for the term of the lease versus the bank’s floating rate).  In short, your business is now at the mercy of Federal Reserve Monetary Policy and the way the bank is managed.  The customer must now get bank permission to make management decisions.

The point is, once again, that “rate” is Not the only factor in making a decision on how to finance a particular piece of equipment.  You have to look deeper.