To Buy or not to buy ... that IS the question

As their company grows, most business owners are faced with requiring additional equipment to support this expansion. So the question becomes, what is the best way to acquire this equipment? Let’s look at this from a balance sheet perspective.

There are three ways to acquire equipment.


One is to buy it from cash-on-hand. This simply depletes your cash assets, with the equipment value being added to its line item.

If you are not going to use your cash, the second way is to get a bank loan. When you do, two things happen. Firstly, the bank requires a down payment of, say, 20%. Using a $50,000 Backhoe as an example, you use $10,000 from your cash and increase the equipment assets by the $50,000. Finally, you add liabilities of $40,000 owed to the bank, with the payments you make to the bank showing up on your P/L as an expense to the business. That expense is deducted from your growth rate, but it is deductible on your taxes. So you have an asset, a liability and an expense. Why would anyone do anything else?

What if you don't want to use, or do not have, the cash for a down payment? You need another alternative.

The third alternative is for the business to lease the equipment. The parties that are involved in a lease-purchase transaction are the vendor, the lessors and the lessee. Let's first consider their roles. The vendor is the supplier of the required equipment. The lessor is going to fund the purchase and is not necessarily a bank. It could be an Insurance Company, a Pension Fund, or an individual or group of private investors. The lessee is the business with a need to make use of the equipment.

The business will first call the vendor to see how much the equipment would cost them, in our case $50,000. They can then contact a Funding Source and within a few days receive a quote as to what it would cost to lease the same equipment. Upon agreement of terms and completion of the necessary documents: the payment schedule, UCC filings etc., the lessor writes a check to the vendor for the entire cost of the equipment and the vendor is now out of the transaction. The lessor gets paid by the lessee according to the terms of the lease, which may run for 36, 48, 60 months or even longer. Using 60 months at a 10% interest rate, $925 per month is paid to the lessee.

Back to our Balance Sheet. The business is required to come up with $1,850 for the first and last payment, compared with the $10,000 required when using the bank. The $925 monthly payments show up as an expense on the P/L, just as when the money was being borrowed from a bank and are, just like a bank loan, deductible.

So what happens at the end of the lease? One common misconception is that the equipment is given back. This is not the case. Leases are frequently written such that at the end of the lease there is what is called a “put”. A “put” is a single additional payment. The “puts” can be as low as $1. You do have to make this payment, however, according to the legal lease terms. When the lessee writes that check for one dollar, the equipment is legally theirs. The equipment now becomes an asset that is paid for, free and clear, with a current value of, say, $30,000. From a tax perspective, this equipment can now also start to be depreciated.

This is a strategy that works in good economic conditions – through the limiting out-of-pocket expenses while allowing additional equipment to be available and used to accelerate the business’ growth.

The strategy also works in poor economic conditions - where often a business needs to get its equipment upgraded in the least expensive way possible in order to continue with its operations. Small wonder that in 2003 there was $223 billion worth of leasing done by American businesses, large and small.

So what is the bottom-line? Consider all your alternatives, consult with your financial professionals and let the numbers and your business plan be your guide.