What’s changed? The premise of the call was this: At the beginning of the decade, money was cheap and the management of capital was less risky. Credit is now tight and a less fungible commodity. In a time of short capital, more than ever, in order to acquire or sell goods and services both consumers and vendors need a financing/leasing plan. Having a leasing strategy will help gain access to cash, avoid costly maintenance bills, lessen the chance of missing technology refresh cycles, or avoid blowing a sale. This market is a double whammy for users: 1) CFO's are tightening the belt and slashing budgets; 2) Financing is going to become a bottleneck to getting deals done. Companies without a financing/leasing strategy will face significant unforeseen problems. Trying to do the job today with yesterday’s technology could increase operating costs by 15%-20% for each year a refresh is delayed. These inefficiencies include higher costs for power, cooling, space, and maintenance as well as staff productivity decreases.
What are the plusses and minuses of leasing? Leasing and loans allow IT customers to acquire technology without incurring large capital cost outlays. The major benefits include:
- Matching benefits to costs – i.e. you pay as you go;
- Buffering technological obsolescence;
- Allowing transactions to be completed with no impact to the balance sheet;
- Improving use of cash;
- Simplifying disposal.
The tradeoffs are:
- Leasees must have good asset management practices in place to know what’s coming off lease;
- Leasing can limit flexibility – e.g. if you have a layoff, you still have to pay for leased PC’s;
- Leasing is a backend business, and you must find partners you can trust;
- Leasees must have processes in place to migrate equipment – the availability of data migration tools and technologies such as virtualization are critical.
The two main types of leases are:
- Operating leases – you don’t own the asset;
- Capital leases – you own the asset.
In order to qualify for an off-balance-sheet item, an operating lease must meet four conditions:
- The lease term must be less than 75% of the asset's useful life;
- The present value (PV) of rent must be less than 90% of the equipment cost;
- The lease cannot contain a bargain purchase option;
- There can be no title transfer for ownership of the asset.
Who are the purveyors of leases/financing options? Leasing is estimated to be a $260B business. Vendor leasing companies have been the primary source of funding and leasing. Generally vendors are the best source because their business is moving technology, and often they are motivated to do a deal. However, third party lessors have no particular stake in the deal other than the financial transaction and can act as independent advisors. Users should be aware that vendors are motivated to lock in a financial footprint and as such may or may not be the best option. The key advice for users here is: Like any acquisition strategy, don’t sole source – balance your supplier portfolio.
What are the important factors to consider in a lease? Users should understand the concept of residual value (RV). RV is the forecast of the future value of the asset. Customers need to have a rough idea as to whether the RV forecast makes sense. Do your research and make sure the RV is reasonable, fair, and aligned to your technology objectives. Customers should also consider:
- Managing the lease – how will the lease be managed, invoices verified, and terms adhered to?
- Tracking – who and how will the terms of the lease be tracked?
- Asset Management – to include change management, upgrades, physical location, etc.
The lease is all about the contract. Users should make sure they involve the right organizational constituents to execute a lease, including internal council, treasury, and legal representation. Other considerations that go beyond the lease rate itself include factors such as return provisions. For example, is the leasee required to return the asset in the original packaging rather than a standard commercial box; are there penalties for upgrading the asset (e.g. memory upgrades); is software transferable at the end of the lease; and are there any licensing nuances that need to be considered? Users should remember that everything is negotiable except the fact that you must make the payment.
Advice for vendors With capital markets changing, the means of payment is becoming even more important. There are two main decision points that occur in a sale: 1) I need/want the technology and can justify the expense and 2) How do I pay for the asset. Vendors must find partners with whom they can share a back-end relationship that can help finalize deals. There is often a concern that leasing slows down the sales cycle. In today’s market especially, leasing can accelerate the sales cycle by establishing a financial footprint and a financing framework that can then be leveraged for subsequent leasing deals.
Top 3 things users should consider:
- Leasing is a back-end business, and you can’t enter into contracts lightly. You need a management team that is committed to the process. Especially in tight markets, management reviews need to be more stringent to ensure that the particular financing option makes sense.
- With budget constraints, be aware of which financing alternatives exist and get a general agreement between the CIO, CFO, treasury, and legal. Have an open dialogue with these constituents.
- Understand the differences and parameters between capital leases and operating leases and make sure you’re not in default of loan covenants or exposed to audits that will force you to restate financials.
Action Item: In a tight 2008/2009 credit market, leasing is becoming an increasingly necessary option for customers to deploy. However customers should balance their financial strategies with leasing, bank loans, and acquisition as viable approaches to aligning financial, technological, and business goals. In order to fully exploit leasing strategies and avoid unnecessary costs, customers should ensure that asset management systems are in place and fully operational.
Footnotes: Sample Lease Agreement