When you talk about buying new equipment, the first thing that comes to mind is how much these will cost. Expanding capacity is essential to the growth of small to mid-sized businesses, but the extra capital to fund major purchases like equipment is almost always unavailable. Should a business owner sacrifice a part of their operating capital to buy a new machine and just hope for the best?
Fortunately, entrepreneurs these days don’t have to be caught in this tough situation. There are equipment leasing options available for those who need equipment now but might not have the ready funds.
This guide discusses the different types of equipment leases that small businesses can avail. But, first, let’s talk about what an equipment lease agreement covers.
What is an Equipment Leasing Agreement?
An equipment lease agreement is a contract where the lessor, or the leasing company who owns the equipment, agrees to let the lessee use the equipment for a specific period in exchange for regular payments. The contract states the duration of the lease, the amount to be paid (monthly, quarterly, or annually), and other special conditions, depending on the type of lease.
For example, the owner of a landscaping business might secure a backhoe lease for three years, during which time they are required to pay the leasing firm $1,000 per month. Because the leasing company owns the equipment, they have the right to cancel the agreement at any time if the business owner violates the terms of the lease.
On the other hand, if all goes smoothly and the end of contract is nearing, the lessee will have the option to either just end the deal and return the machine or purchase the backhoe from the company for a much smaller amount to finally own it. All these will be reflected in the lease contract.
4 Types of Equipment Leases
There are different types of equipment lease agreements, each with their own list of benefits and risks. Let’s look at the most popular ones.
1. PUT or Purchase Upon Termination Lease
The example we provided above is a PUT option lease. Typically, the purchase price is represented as a percentage in the lease agreement and will be fixed all throughout. This means that if you agreed to a 15% Put, you can buy the equipment at the end of the lease for 15% of its purchase value. The predictability of payments and amounts is a huge benefit to the small business owner who might already be challenged with a tight cash flow.
- Predicability of payment amounts
- Ability to purchase at end of agreement
2. Capital Lease
Also called a finance lease, a capital lease is a contract where the lessor agrees to transfer ownership of the equipment to the business owner at the end of the lease period. It is relevant for tax purposes because the lease itself will be recorded in the balance sheet as an asset. It is beneficial for business owners leasing high-value equipment because the depreciation and interest payments can help lower their taxable income.
- Lowers taxable income
- Good for long-term equipment
- Cannot be canceled
3. Operating Equipment Lease
An operating lease, also referred to as a true lease, is similar to a capital lease, but without the transfer of ownership in the future. By simply renting and not owning the equipment, business owners can keep any mention of the asset from its balance sheet by recording the payments as operating expenses.
- Tax benefits
- No transfer of ownership
4. TRAC Lease
A Terminal Rent Adjustment Clause (TRAC) lease is a flexible type of lease agreement that’s usually applied to heavy equipment and vehicle fleet leasing contracts. In this arrangement, the lessor enters into a credit agreement with the business owner and then purchases the equipment from the vendor that the lessee chooses. The lessee then agrees to pay a fixed monthly amount for a specific period. They can also negotiate to have a large residual payment (or end-of-contract lump-sum payment) to lower their monthly obligations.
- Fixed payments or end of contract lump-sum payment
The Components of an Equipment Leasing Agreement
What are the different components of a lease agreement? We highlight them below.
The lease duration will depend on the business’s needs. Some equipment is better as a short-term lease, while others are better for long-term agreements. For higher-cost equipment, a longer-term lease is typically more favorable.
Financial terms such as the timeline, when monthly payments are due, and the last due date for late payments. Late payment penalties should also be laid out.
The periodic interest and principal payments will be outlined in the agreement for the lessee to evaluate their cash flow. The payments are spread out over a period of time until the contract expires or the lessee takes ownership of the equipment.
The lessee needs to know the market value of the equipment before signing the agreement. This allows the lessee to assess the potential insurance costs for the equipment.
Depending on the lease, the lessee might be required to pay taxes on the equipment. This will be laid out in the agreement to avoid unexpected costs.
The equipment leasing agreement will have clear cancellation provisions. A business can decide to cancel the agreement midway through the lease agreement if the equipment becomes defective or obsolete. Penalty rates may be disclosed here for cancellation.
The last component of an equipment leasing agreement is the renewal options for the lessee. The renewal terms and guidelines will be outlined in the agreement for when the original lease agreement expires.
Need Advanced Equipment Soon? Charter Capital Can Help
As a small business owner, you need all the funds you have to pursue initiatives that will scale and grow your operations. If the cost of your equipment will only eat into your coffers, it’s time to consider securing an equipment lease from a trusted equipment leasing and financing provider. Charter Capital has been helping small to large entrepreneurs acquire the machines and tools they need to succeed since 1977. We offer assistance for practically every type, size, and number of equipment you need. Contact us today for a consultation.