Whether you choose to lease, pay cash, or obtain a bank term loan, choose the best equipment-financing option for your practice
Nowadays, just about everything you see in your office can be leased. Even some things you cannot see can be leased as well. In this article, we will explore the ins and outs of leasing equipment for start-up or more established businesses.
Start-up businesses are viewed as higher risks than established ones. That is because more than 50% of start-up businesses fail, which leaves someone holding the financing package. Therefore, banks usually refrain from lending their depositors’ money to start-ups.
The Federal government created the Small Business Administration (SBA) Loan Program to help these businesses get started. An SBA loan is actually not a loan from the government; rather, it is a loan guarantee from the government to your bank based on established criteria. Those criteria usually (but not necessarily) include some amount of collateral as well as your personal guarantee. These types of loans are called term loans.
Lease or Term Loan?
Leasing is often a better choice than a term loan for a start-up in that less of your capital or collateral will be required. Also, the application process is very short—usually a few days. When you apply for a lease, your credit score will be seen as a key component in the process. If you have a history of making timely payments, you are a good initial candidate for leasing.
If your business is a start-up, you may still pay a somewhat higher interest rate than if your business is more established; but again, less capital is required. For a medical spa with five treatment rooms and two lasers, as much as $300,000 may be required to purchase all the office and treatment equipment.
A term loan scenario for a start-up might require a cash investment of 30% or more of the equipment’s value (more than $90,000), while a lease of the same equipment for 36 months might require only 10% of the equipment’s value.
In both cases, you have to demonstrate the ability to make payments on time. One scenario is to lease the equipment and to obtain a bank line of credit for operating capital. If your business has been profitable for more than 2 years, you will likely receive preferred treatment from banks. Term loans or credit lines for businesses with good credit usually cost less than leases.
Lease financing also gives you more options near the end of the lease. Since you have become accustomed to making a fixed payment every month, you can upgrade to new technology very easily. If you have been a good customer, you will be able to give back your current equipment and lease new items.
I asked Douglas Delaney, executive vice president of sales at Cynosure in Westford, Mass, about how customers finance their lasers. He said, “Most sales are done through lease financing (about 70%), while about 20% are made through bank term loans and about 10% are paid in cash.” Typical lease terms are 5 years.
Two Types of Leases
There are two types of leases: capital leases and operating leases. In a capital lease, you are essentially borrowing money to buy the equipment. At the end of the lease, you will typically own it by paying $1. You will consider the equipment to be an asset and depreciate it on your balance sheet.
Usually, this type of lease is treated like a term loan. However, the lease terms may be more favorable to you than those for a term loan. A lower deposit may be required, or collateral may not be required as it would be for a term loan.
In an operating lease, it is assumed that you will use the equipment for a portion of its useful life and not own it at the end of the lease (although you may be given a “buyout option” at the end of the lease). This type of lease is fully expensed as you make each monthly payment. It typically includes all maintenance and warranties, and it gives you a fixed equipment cost for your monthly payment with no contingencies. If you like to have the latest and best-available equipment at all times, the operating lease is your best choice.
Equipment leases typically include maintenance and extended warranty options. It is wise to take them—your monthly payment becomes fixed and covers all contingencies.
When it comes to maintenance and warranties, many such contracts are limited in that maintenance may cover only parts, not labor, and in some cases only certain parts. In addition, warranties can be limited. In any event, find out early on if maintenance and warranties are included, to what extent, and for how long.
The Business-Tax Impact
Whether you pay cash, receive a bank term loan, or lease will affect your business taxes accordingly. Therefore, you should solicit input from your certified public accountant (CPA) or tax attorney to determine the specific impact that each method will have on your business.
Normally, if you pay cash, you can depreciate the equipment over time or in some cases expense the entire amount immediately. If you pay using a term loan, you can generally deduct the interest payments and depreciate the equipment. If you lease the equipment, you may be able to expense the entire monthly lease payment.
If you cannot deduct the entire payment, then you can certainly deduct some of it. This depends on the type of lease. If you have both cash and flexibility, then your CPA will determine the most tax-advantageous way for you to obtain the equipment.
A good accountant will also tell you that you should not make business decisions based on their tax consequences alone. Therefore, you should consider the nature of the equipment and its likely useful life to your office before you decide how to purchase it. If you think you will keep the equipment for more than 6 years, then buy it for cash if you have the cash. You will pay less for it (no finance charges will be added), and you will be able to expense it or depreciate it. This is the lowest-cost option.
When you no longer want the item, you can sell it for its current market value. This is called a “sale-leaseback” option.
If you own valuable equipment in good condition, a sale-leaseback can help you obtain operating capital for your business. You essentially are turning over the equipment to a leasing company and then leasing it from them.
In return, the company gives you the purchase price in cash, and you make monthly payments on the lease for the agreed-upon term. Again, this is an alternative to obtaining a term loan from a bank or having to pledge all your equipment as collateral for a term loan.
Choose Equipment Before Terms
I strongly suggest that you choose your equipment before you choose your payment terms. I do not recommend that you select equipment based on the financing choices available to you. Your primary responsibility is to run a successful practice using technology that meets your criteria for function, quality, and safety.
It is also important to note that most leasing and financing agreements require the buyer or lessee to post a personal guarantee in the event that the lessee defaults on the lease or financing package, regardless of whether the buyer or lessee is a corporation or individual.
According to Mac Fadra, executive consultant at Beautiful Forever, a medical-spa industry consulting firm, “The intense competitive environment among laser vendors and suppliers is shifting bargaining and negotiating power into the hands of buyers and physicians. Many innovative buyers have negotiated direct lease terms with vendors and suppliers—including percentage-of-revenue arrangements; profit sharing; daily, weekly, or monthly rentals; and other creative arrangements—without the need for personal guarantees on the equipment.”
Leasing has become a preferred financing method for business equipment, and it can be a very useful way to help you operate your business. If you are considering a lease, please be sure to review it with your CPA before you make your final decision.
Cheryl Whitman has spent more than 2decades working and consulting in the beauty industry. She is the founding board member of the Medical Spa Society and an active member of the Day Spa Association. She is a frequent contributor to Plastic Surgery Products. She can be reached at (201) 541-5405 or [email protected].