Translating the Buzzwords
Shopping for some new equipment? More powerful computers, perhaps, or a better phone system? These days many people are swayed by the flexibility of leasing over buying. For one thing, lease rates are fixed. Also, leasing companies can finance 100% of the purchase for three to five years. And if the leased equipment becomes outdated during the term of the lease, leasing lets you upgrade; if you own the equipment, you're stuck.
Still, there's a lot of confusion over leasing terminology. Some deals represent more than one category of lease. And some "leases" aren't really leases at all but installment purchases. Geoff Culver, cofounder of Provista Software, in San Jose, Calif., encountered some of that complexity last winter -- after being told by his auditor that he had structured his $70,000 computer deal as a capital lease instead of an operating lease, as he had intended. The result: violation of his bank-loan agreement. Below is a primer on some of the most basic leasing terms:
Capital lease. An accounting term for the way a lease is carried on the lessee's balance sheet. Capital leases are treated as long-term debt. If you're concerned about how your bankers will react to additional leverage, you're better off structuring the deal as an operating lease.
Operating lease. This is carried off the balance sheet for accounting purposes, which means it's not as obvious to lenders as a capital lease is. Operating leases tend to be structured for shorter terms than capital leases, and the equipment is sometimes maintained by the lessor.
True lease. Any deal that qualifies as a lease under federal-income-tax rules. In a true lease (which can be either a capital or an operating lease), the lessor owns the equipment and depreciates it while the lessee deducts lease payments as expenses. Unless you have a fixed-price purchase option at the end, this can be an expensive way to obtain equipment.
Finance lease. A noncancelable, long-term lease requiring no up-front investment from the lessee, who typically pays for insurance and maintenance. Could be set up as either a capital or an operating lease.
Full-payout lease. A type of finance lease that commits the lessor to several years of payments, no matter what. With a full-payout lease, you get no protection from obsolescence.
Leveraged lease. A deal in which the lessor puts up some of the purchase price from its own funds and finances the rest with third-party debt. As equipment owner, the lessor gets some tax benefits, which boosts its return; it may or may not pass those along to the lessee as lower lease rates.
Master lease. The leasing equivalent of a credit line. A contract under which the lessee is able to add a set amount of new equipment without having to negotiate new terms and conditions each time. The agreement usually spells out the types of equipment covered and the period of time.
Net lease. Any lease in which the lessee assumes responsibility for operating expenses (insurance, maintenance, and taxes). Most varieties of leases, with the exception of short-term rentals, are written this way.
Open-end lease. A conditional sale whereby the lessee guarantees that the lessor will receive a minimum value at the end of the lease and agrees to make up any shortfall. Mostly used in connection with vehicle purchases.
-- Bruce G. Posner* * *