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Common Pitfalls of Equipment Leasing

Pitfalls of Leasing

Tom Williams

September 25, 2008

If you are a business owner considering equipment leasing, keep in mind the legal adage “Possession is nine-tenths of the law”.  Paying to use equipment for a specified period of time can save you money, particularly when what you need is expensive, requires frequent maintenance and/or is often upgraded.  However, if you don’t understand certain standard terms included in most contracts, you may get some costly surprises at the end of your lease.  Here are five common pitfalls and strategies to avoid them.

Pitfall #1: The End-of-Term Surprise

To be flexible according to their customers’ needs, leasing companies typically offer four ways to close out a lease:

·        Purchase of the equipment for a fixed amount

·        Purchase of the equipment for Fair Market Value

·        Return of the equipment

·        Continued leasing of the equipment for a specified period (this was a popular profit center in the early ‘90s, but is no longer as common)

Many business owners assume they already know how leasing works and sign a contract without fully understanding these options.  When they get a bill for the residual amount, a purchase option at additional cost, or worse – an automatic 12-month lease renewal -- they become upset. 

Smart Strategy:  Be savvy to make the most of leasing and avoid getting caught short-handed.   Be sure you understand what you will own and what you will owe at the end of your lease before you sign a contract.

Pitfall #2: Personal Responsibility for a Business Lease

Required by 90% of  leasing companies, the Personal Guaranty pierces the “Corporate Veil,” making the business and its owner equally responsible for paying the lease.  In the event that the business experiences financial difficulty, the owner can be held personally responsible for paying out the remainder of the lease.

Smart Strategy:  In financial planning for yourself and your business, be prepared for this liability. 90% of all leases have a Personal Guaranty so be aware going into the lease.

Pitfall #3: Required Insurance at an Additional Cost 

If your insurance policy will not cover the equipment you plan to lease, or you do not have insurance, most leasing companies will add the cost of coverage to your invoice.  Some leasing companies will charge a fee for not having insurance rather than adding insurance. 

Smart Strategy:  Don’t assume insurance comes with the contract – ask for details about the type and cost of coverage.

Pitfall #4: Sales Tax and Uncle Sam

If you lease equipment, you will need to pay state sales or use tax and, in some cases, personal property tax.  You may end up paying more taxes than necessary if you do not fully understand how they are handled in the contract.

Smart Strategy:  Ask your leasing agent how they interpret taxes in your state and the most efficient way to minimize these expenses.  For example, in Florida there is a $1.00 versus a $101.00 buyout.  If you choose to buy your equipment at the end of the term for $1.00, you will pay sales tax on the whole outstanding balance.  However, with a $101.00 buyout, you will pay sales tax on the monthly payment only, which can represent substantial savings.

Pitfall #5: Limited Recourse

A leasing contract is a three-way contract in which you agree to pay the leasing company back for the equipment from the vendor you chose.  The leasing company agrees to pay your vendor and you agree to make payments -- the rest of the contract covers the terms of what happens if you don’t make your payments.  The leasing company can’t pick the equipment for you, and you are responsible for all the monies under the lease regardless of the effectiveness of the equipment your vendor provides. 

Smart Strategy: Choose your vendor and equipment carefully.  Read your contract and ask questions, making sure you understand your responsibilities as well as your options.

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