Reprinted from ALM’s Law Technology News - How to determine the most advantageous way to pay for legal technology equipment.
By Suzanne M. Cutshaw
Once your firm has made the decision to acquire new equipment, the next step is to determine how to pay for it. Do you use cash from normal operations? Is a partner capital call required? Is bank financing appropriate for high tech equipment? Should you consider a lease?
Here are four primary reasons to consider the leasing alternative for today's high tech equipment utilization: The technology itself, possible tax advantages, appropriate cash management and flexibility factors.
Most law firms today find that high-tech equipment, such as computer and telecommunications hardware, has a useful life of only three to four years. Depending on the size of your firm and the competition in your specific practice area, you are probably going to replace computer equipment approximately every three years-- (even less for many firms.) Technology changes so rapidly that a system that is state-of-the-art today may not even run the software your firm needs next year. Many times, the advances in software demand an upgrade or replacement of the existing hardware. With equipment obsolescence on the rise, it makes economic sense to use computer equipment rather than own it. That is the definition of equipment leasing.
Tax Advantages
If your firm is in a position to benefit from tax advantages of a properly structured lease, this increases the attractiveness of leasing. With the proper lease structure, your payments may be fully deducted as an expense item.
If you match the useful life of the equipment to the term of the lease, you will probably expense the system over a shorter time period than depreciation allows. A shorter tax life means a faster write-off, and a tax saving for your firm.
Some firms have also found that leasing significant purchases has allowed them to avoid the Alternative Minimum Tax (AMT) penalty. Your true cost of a lease must include an after tax analysis.
A lease may significantly enhance your firm's cash management. Your bank borrowing capacity is preserved for use in normal operating expenses, working capital, bonus plans, etc.
Capital is reserved for appreciating assets, mergers, real estate, expansion programs, investment opportunities, etc.
Also, with a lease, future partners/shareholders share in the investment in technology, rather than the burden bearing solely on your existing firm owners. Additionally, leasing provides an additional source of capital for your firm. A larger pool of credit is available to fund your growth.
You can also benefit from lessors who have industry knowledge and offer assistance in far more than simply financing. Asset management is easier with the appropriate lease, one where upgrade opportunities exist during the term of the lease, and where lease termination options include extensions or return of the equipment.
Some firms also benefit from flexible structures that offer skip-or step-payment leases. For example, you may determine that it is in your best interest to skip a lease payment during the month when the liability insurance premium is due. Or you may plan in advance for additional technology expenses that will occur at a later time by utilizing a step-down payment structure, essentially leveling your technology budget. Experienced lessors can normally provide assistance in disposing of your existing obsolete equipment, too.
With all of the practical and financial benefits available with the appropriate equipment lease, it is in your best interest to investigate how leasing will work for your firm. Determine your specific goals and objectives for your technology projects, then analyze its value to your firm.
Suzanne M. Cutshaw is vice president, legal division, of American Equipment Leasing, which is based in Reading, Pa.
LEASING CAPITAL EQUIPMENT: A VIABLE ALTERNATIVE FOR FIRMS
Reprinted from ALM’s New York Law Journal By John D. Dondey
LIKE MOST OTHER businesses, law firms - from single-attorney practices to 500-attorney multinational firms - need capital equipment to function and maintain a competitive edge. But law firms are not like most other businesses in important ways, and their capital equipment needs often differ from those of other types of businesses.
Law firms need unique types of capital equipment as well as standard business machines. They often need large computer networks, and they cannot afford to purchase hardware and/or software that will be obsolete in six months. Most of all, law firms need to stay competitive and require flexibility in equipment acquisitions in ways that many businesses do not. These are only a few of the reasons that have lead many law firms to turn to leasing for their capital equipment acquisition needs.
The legal industry is one of the largest lessees of the following four equipment types: computer networks, telecommunications equipment, business machines and office furniture. In fact, the legal marketplace is the top lessee in the business machines and telecommunications equipment segments. Given the special needs of law firms - small and large alike - these statistics should come as no surprise.
Law firms need a considerable amount of equipment - computer networks, business machines, legal libraries - to function properly. Often, especially in times of office expansion, relocation or merger, the cost of acquiring all of this equipment can be financially prohibitive. Firms are faced with a decision either to spend capital they do not have or could put to better use, or to do without equipment that they desperately need to function efficiently and stay competitive. In the face of this type of decision, leasing can almost quite literally come to the rescue.
Benefits
Leasing allows firms to acquire equipment with no initial capital outlay. Not only are firms able to conserve capital and bank lines of credit, but they can also generate revenue for the use of the equipment before they begin to pay for it. Copies made on a new photocopier can actually be billed to a client as the firm pays for the machine. In other words, when firms lease, they almost always see an immediate return on investment from the equipment.
In addition, an issue law firms - especially large firms using major local or wide area networks - must consider is that of potential equipment obsolescence. The chance of a new copier or fax machine becoming completely obsolete in a short period of time is fairly low. But the chance of a new computer hardware or software system becoming completely obsolete in a short period of time is often frustratingly high.
Since upgrade and trade-in options can be written directly into a lease, firms can put aside their fears of obsolescence, as well as those of having to remarket obsolete equipment. In the case of computer and telecommunications equipment, the flexibility of leasing can far outweigh any perceived benefits of ownership.
Finally, leasing provides other, more commonly stated benefits: properly structured lease payments can be tax deductible; lease rates remain the same for the life of the lease, unlike some floating rate bank loans; and leasing can often help firms circumvent yearly capital budget limitations. The benefits of leasing are clearly abundant and various, and it is no wonder why many law firms have chosen the leasing route.
Lease Rates
However, there are some who still feel that equipment ownership is less expensive in the long run due to exorbitant lease rates. On the contrary, return on investment, security against obsolescence and potential tax savings aside, firms that have looked at leasing have discovered that lease rates for the legal industry are pleasantly and surprisingly low.
Over the years, leasing companies have found that attorneys are excellent credit risks. Since the likelihood of default is very low, lease companies are able to offer lease rates to law firms and legal professionals that are not offered to other business segments. Put simply, attorneys receive low rates because they represent low risk.
Other naysayers insist that leases cannot cover software and other softcosts such as delivery charges, warranties, etc. With reputable leasing companies, however, this is simply not true. Even law firms who lease may not be aware of all of the different types of equipment, as well as all of the extraneous costs that can be placed on a lease.
Leasing companies who cater to the legal market lease such soft equipment as software licensing agreements and law libraries. In addition, the best leasing companies will add all taxes, delivery and installation costs, warranty fees, training and even insurance costs into the lease payment. Moreover, master lease agreements allow law firms to place multiple suppliers on the same lease agreement.
So, for example, a firm could acquire an entirely new local or wide area network, including all hardware, all software, all delivery and installation costs (even for multiple sites), and all taxes and other miscellaneous costs, on a single lease for a single monthly payment and no major initial capital outlay. It sounds simple, and it is.
Conclusion
With leasing's numerous benefits and the low lease rates offered to the legal industry, law firms - large, small and in-between - can only be expected to continue leasing in greater and greater numbers. And as the legal community continues to place its considerable business with leasing companies, more and more leasing companies will begin to look for ways expressly to service the legal community. That sounds like a win-win proposition.
EQUIPMENT LEASING BY INDIVIDUALS
Reprinted from ALM’s The National Law Journal - Tax & Investments: A Special Report
By James S. Kaplan
For some years, leasing has been an accepted and widely used method of financing the purchase or use of heavy capital equipment. The basic principle of equipment leasing is that the tax and economic benefits attributable to investment in equipment used in an activity can more effectively be utilized by a taxpayer other than the one that engages in that activity. Such transactions have largely been limited to institutional investors' (such as banks and insurance companies) purchasing discrete items of heavy equipment such as an airplane or a power plant. But there has recently been an increasing recognition that individual investors can participate in properly structured leasing programs, and that the basic principles of leasing can be applied to many more businesses than those to which they have traditionally been applied. This article explains the reasons for the recent proliferation of investment programs that seek to involve individual investors in the ownership of equipment used by operating businesses, as well as the tax principles affecting the operation of such programs.
Basic Principles
Generally, the two basic tax benefits attributable to the ownership of tangible personal property are depreciation and investment tax credit. With the enactment of the Accelerated Cost Recovery System (ACRS) by the Economic Recovery Tax Act of 1981 (ERTA), these benefits have become significantly more attractive. Under the ACRS system, the vast majority of all business equipment will qualify as either three-year or five-year property, which means that, depending on its guideline class life under prior law, it is depreciable over either three or five years. Under ERTA, investment tax credit of 10 percent is generally available with respect to investments in five-year property, and investment tax credit of 6 percent is available with respect to three-year property. As is discussed below, it is frequently possible, through the use of leverage, for a purchaser of equipment to effectively obtain these benefits by making a cash investment that is considerably less than the purchase price.
Many industrial businesses, which are heavy users of capital equipment, are in cyclical industries such as transporation or heavy manufacturing, which have erratic earnings. As a result, these users are frequently unable to avail themselves of the signficant tax benefits attributable to ownership of the equipment they need. Furthermore, such firms frequently have neither the capital necessary to finance the acquistion of such assets, nor the desire to speculate on fluctuations in the market for such equipment. Leasing transactions provide users with a means of obtaining equipment without the necessity of a large capital outlay and at a lower rental cost than if the tax benefits of equipment ownership were not effectively utilized. They provide to investors that are significant taxpayers the opportunity to receive the tax benefit of ownership of equipment, and to participate in the economic benefits of the residual market for the equipment.
Traditional View
Although these principles are as fully applicable to transactions with businesses having numerous items of tangible personal property (such as a typewriter or car rental business) as they are to businesses involving one discrete piece of equipment, traditional leveraged lease transactions have generally been limited to institutional investors and large single pieces of equipment for two reasons. One, it has been administratively easier to deal with one large piece of equipment and one lessee than with servicing many small pieces of equipment and many short-term leases. Two, since 1971, the ability of individuals to claim investment tax credit with respect to leased equipment has generally been limited to property that is leased for a term (including options to renew) that is 50 percent less than the useful life of the property (as defined for tax purposes), and with respect to which the business deductions in the first 12 months exceeds 15 percent of the rental income-produced by such property.
Notwithstanding these impediments, the generally broad market for tax shelter investment by individuals, as well as the increased tax advantages under ERTA, have caused many promoters and businesses to realize that a properly structured program providing for individual investment in equipment of an operating business can yield significant benefits for all involved.
Typical Fact Pattern
A typical fact pattern would involve a leasing company, ABC Rental Co., that places equipment with end users, and is experienced in the equipment market. Most users would rather rent than purchase the equipment because they lack the capital to make such purchases and often are not able to use the tax benefits attributable to ownership. The exact nature of the equipment is actually immaterial -- it could be cars, typewriters, computers or telephones -- so long as it is tangible personal property for which there is a ready rental market, preferably of a type that can be leased on a limited-term basis to different customers.
ABC knows the market for use of the equipment in which it deals and has the capability of distributing it, but lacks the capital necessary to purchase the equipment it needs to place with users. ABC is thus a natural candidate for financing from a program involving tax shelter investors.
Under such a program, ABC would have the desired equipment, purchased either directly by individual investors or by a partnership of investors. The investors would then have the rental company lease the equipment to third-party customers as their agent. In this way, the individual investors are the owners of the equipment and receive the tax benefits of ownership -- i.e., ACRS depreciation and investment tax credit. The investors also have the economic benefits and risks of ownership, since, as the owners of the equipment, they receive the rental income and participate in improvements in both the rental market and in the residual market upon sale of such equipment. On the other hand, the investors bear the risks of economic loss in the event the equipment is damaged or destroyed or in the event of weakness in the market.
Thus the leasing company serves as a distributor and marketer of equipment to customers, whereas the individual investors have the tax and economic benefits and burdens of its ownership. In this way, the benefits and burdens of ownership of the equipment reside with parties in a better position to use them, and this should translate into a lower rent for users.
Tax Issues
The structure outlined above, which was widely used in the financing of railroad box-cars some years ago, is now being used with increasing frequency in the financing of truck and car rental operations as well as office equipment and computers. It raises the following tax issues:
Investment Tax Credit. It is critically important in many such programs that the individual investors be entitled to claim investment tax credit with respect to the equipment that they have purchased. In order for such credit to be available, the investors must not be subject to the non-corporate lessor restriction of Sec. 46(e)(3) of the Internal Revenue Code. That section prevents individual investors from claiming investment tax credit with respect to leased property with respect to leases which are either: (1) for more than 50 percent of the property's pre-ACRS class life; or (2) with respect to which the sum of the business deductions allowable solely under IRC 162 in the first 12 months of rental does not exceed 15 percent of the property's rental income.
If the program is structured so that the leasing company is acting as the investor's agent and the equipment is of a type that is generally used on leases lasting less than two years, the 50 percent of pre-ACRS class life requirement should not be a problem, since no lease will extend beyond the permitted period.
It is important, however, that the arrangement be structured in such a manner that the leasing company itself is acting at all times as the investor's agent, and not as lessee. If the IRS were successfully to assert that the equipment should be deemed to be leased to the leasing company, the 50 percent of useful life requirement of IRC 46(e)(3) would be violated.
Fortunately for investors, the argument that a leasing company acting as managing agent for a group of investors is actually a lessee under a management agreement has been rejected by the Tax Court in Meagher v. Commissioner, 36 T.C.M.1091 (1977), and more recently by the IRS itself in a Technical Advice Memorandum, Private Ruling 8241010. On the other hand, in McNabb v. U.S., 81-1 U.S.T.C. Para. 9143 (D. Wash. 1980), the court held that an agreement that was claimed to create an agency relationship was in fact a lease, where the agent had broad rights to deal with the property and actually bore the economic risks of loss.
The requirement that the operating business expenses exceed 15 percent of the gross rental income in the first 12 months should not be that onerous, depending on the nature of the equipment. Frequently the leasing company will be paid a management fee and a maintenance fee for managing and maintaining the property, and these will aggregate to more than 15 percent of the first year's rental income.
ACRS Depreciation. As indicated above, equipment will generally be depreciable over three or five years, depending upon the class life previously in effect. As in all tax shelters, the basic assumption is that the economic useful life of the equipment significantly exceeds the depreciable tax life.
If the equipment is purchased by a partnership of investors, ACRS depreciation in the first year will be limited to that pro rata portion of a full year's depreciation based on the portion of the year during which the partnership is in existence and is engaged in the business. If the program can be structured so that each individual investor owns the property directly and not in partnership, there may be an interesting opportunity for many investors to obtain a full year's ACRS depreciation in the year in which the investment is made. Under the normal ACRS rules, an owner of property that has a full taxable year would be entitled to the full ACRS deductions for the first year the property is acquired (i.e., 15 percent for five-year property and 25 percent for three-year property) irrespective of when during the year the property was placed in service. Since an individual investor will have a full taxable year for the year the property is acquired, the only question is whether and under what circumstances the Treasury will, under ACRS, limit the investor's taxable year for purposes of depreciating the equipment he is purchasing to less than a full year.
IRC 168(f)(5) gives the Treasury the authority to issue regulations determining when a taxable year begins under ACRS. No such regulations have yet been issued. But the pre-ACRS regulations provided that, for depreciation purposes, the term taxable year did not include any period prior to the time the person seeking to depreciate the property began engaging in a trade or business or began holding depreciable property for the production of income. Treas. Reg. 1.167(a)-11(c)(2)(iv). This regulation has generally been interpreted to mean that an individual whose sole activity is that of an employee would not be entitled to a full year's depreciation in the year the property is acquired. However, it has generally been believed that a person who is self-employed or has other business interests or other investments in depreciable property is entitled to a full year's depreciation. This can be a substantial benefit in the first year to qualifying investors in equipment programs, particularly since such a full year's ACRS depreciation is specifically not available with respect to investments in real property (IRC 168(b)(2)) and retroactive allocations of partnership loss are forbidden. IRC Code Section 706(c).
Leverage and At-Risk problems. In order fully to realize the tax benefits available from equipment investments, most programs have considerable leverage. A cardinal principle of tax shelter investment is that debt incurred to purchase property is fully includable in tax basis for purposes of computing depreciation, investment tax credit and other tax attributes. The ability of an individual investor to claim losses or credit attributable to non-recourse debt in non-real estate transactions, however, is limited by the at-risk rules of IRC 465, and the investment credit at-risk rules of IRC 46(c)(8). Under these rules, an investor is generally only able to claim losses or credits up to amounts for which he is at risk. However, these limitations have not proven to be an insurmountable obstacle to individual investor participation in equipment leasing programs.
Such programs are frequently structured so that individual investors generally pay approximately half the purchase price of the equipment they are buying with cash and recourse notes with respect to which they are personally liable, and the balance with non-recourse financing pursuant to which the lender receives a first lien on the equipment. Under such arrangements, the investors are entitled to include in their tax basis for the property for depreciation purposes the full amount of the purchase price (including recourse and non-recourse debt, assuming that the purchase price does not exceed the property's fair market value). But they can only claim losses from the activity in an amount equal to the amount of cash, plus the principal amount of the recourse note. Since the investor will be liable to pay the amount of the note, such recourse financing significantly increases his amount at risk, should the economics of the investment not turn out as anticipated.
As noted below, insufficient cash flow to amortize debt can have particularly unfortunate consequences in these transactions because foreclosure of the property by the lender will be treated as a sale, which may result in a recapture of the tax benefits. On the other hand, if the activity generates the economic profits projected, so that there is sufficient cash flow to pay principal and interest on all notes as well as a cash return to the investors, the at risk rules will not be a problem.
Under IRC 46(c)(8), non-recourse debt can be included in tax basis for investment credit purposes if the loan is from a qualified lender and the investor is at risk with respect to an amount equal to 20 percent of the cost of the equipment. Thus, if properly structured, the non-recourse financing should be fully includable in investor tax basis with respect to which investment credit is claimed. Similarly, since the at-risk rules of IRC 465 only limit the amount of total losses that an investor can claim, and not the actual depreciable basis of his property for tax purposes, the accelerated nature of the losses from depreciation deductions provided by leverage financing will still be available up to the amount for which the investor is at risk.
Furthermore, under IRC 465, an investor's at-risk amount increases to the extent that taxable income generated from operations is used to pay-off principal on the underlying non-recourse debt. Thus, in the early years an investor is likely to receive the full benefit of ACRS depreciation deductions, and in the later years he will be entitled to the benefit of any disallowed losses to the extent that principal on the non-recourse financing is paid off. By the time the non-recourse financing is extinguished, the investor will have had the full benefit of ACRS depreciation on the full purchase price of the equipment, and will own it free and clear.
Recapture and Economic Risks. It cannot be strongly enough emphasized that the critical element in these operating equipment leasing programs is the economic viability of the business in which the investment is made. If for any reason the equipment owned by the investor cannot be leased for a rental sufficient to service the principal and interest on the debt the investor has incurred, then the lender presumably will foreclose on the equipment. If this happens, such foreclosure will be deemed to be a sale for tax purposes. The investor will not only lose his entire cash investment, but he will also have to recapture at ordinary income an amount equal to the difference between the amount of principal on the debt foreclosed upon, and his depreciated tax basis.
Furthermore, depending on when the foreclosure occurs, he may have to recapture a percentage of the investment credit claimed. It is indeed unfortunate that completely proper and innovatively structured programs of tax-oriented investment can prove disastrous if there is insufficient attention by both promoters and investors to the real economics of the market for the equipment in which investment is made. This was the problem with many of the railroad boxcar programs of the early 1980s. Hopefully, soundly financed equipment programs currently being offered will avoid these problems, and will permit leasing to individual investors to play the proper role in the economy that it should and can.
AUTOMOBILE LEASING CAN OFFER TANGIBLE BENEFITS
Reprinted from ALM’s Legal Times - Money and Taxes
By Suzan Richmond
It's clear, under current law, that though auto leasing is advantageous in certain circumstances, in the long run, you'll generally save more by buying your car. Tax benefits provided by the Economic Recovery Tax Act of 1981--the 6 percent one-time investment tax credit on a new car puchase and depreciation deductions that allow a buyer to recover costs in three years--work to the advantage of an individual who buys rather than leases a comparably priced automobile.
To me, there are absolutely no tax advantages, said W. Murray Bradford, president of the Tax Reduction Institute. In most cases, leasing can cost you the investment tax credit--which lessors usually keep, and in most cases, if they pass it on, will adjust the monthly rate upward. There are, however, financial advantages. In fact, the reason Bradford leases his company's business car is strictly for cash flow purposes. We didn't have to part with cash up front, he noted.
Similarly, Brian Barkley, a sole practitioner in Rockville, prefers to pay the lower monthly costs of leasing his BMW rather than paying out thousands for a down payment, which can cost from 20 percent to 30 percent of a car's purchase price. Purely and simply, Barkley added, leasing frees up cash to spend or invest in other things.
Leasing Offers Convenience
Leasing also made sense to Bethesda lawyer Stanley Jacob, who thinks all cars are built to self-destruct in 24 months. I burn them out. His policy is to trade in frequently, and he said he leases, on the basis that I won't build up any equity in a car anyway. There's the convenience of being able to walk away once the lease term ends, without having to invest in a depreciating asset or to look around for buyers. And by driving relatively new cars, an individual who leases also will pay somewhat lower maintenance costs.
Industry experts estimate that 40 percent of new car purchases will be financed through leasing by the end of the decade, but before deciding whether you want to join the growing number of members of the car-buying public that is switching to leasing, you should understand a typical car leasing arrangement. Banks are now getting into the business, saying that by eliminating the middlemen, they're able to offer the least-expensive financial packages available. Car dealerships also are leasing vehicles, saying that they can give the best automotive service to customers who lease their brand. But it pays to shop around. You'll sometimes see ads for full-maintenance leases, but that service can cost you up to $70 extra a month, even if you don't ever need it. Many lessors offer a range of makes and models at widely varying prices, and often you may be able to negotiate terms of the lease.
Barkley said the independent lessor he uses--BC Leasing of Bethesda--was willing to match one bank's lower monthly rates, as well as intervening on his behalf with the dealer in order to obtain servicing and a loaner car when his own was in the shop. BC also agreed to pass on to him the investment tax credit without lowering the stated monthly payment charge. The bank was not willing to pass on the credit.
What's a typical lease? The standard offered by the industry covers a 36 or 48-month term. An amount equivalent to two months' worth of payments--usually one monthly payment and a security deposit is paid at the outset. Maryland and District residents must pay an 8 percent usage tax each month, which usually is not figured into the quoted fee. Virginia residents pay a personal property tax. The lessee is also responsible for insurance coverage and the cost of maintenance and repairs--unless it's a full-maintenance lease.
Closed or Open End?
Two kinds of leases are available: closed-end or open-end. Most are closed-end leases, where you can walk away from the car at the end of the payments, unless you abuse the car. Additional charges for wear and tear, as well as any mileage restrictions should be written up in the lease. You could be charged anywhere from 8 cents to 15 cents more a mile beyond the agreed-upon limit. Find out how ordinary wear and tear affects the return of any security payment or deposit required. Lessees also should determine whether they are responsible for the unpaid portion of the lease should they desire to terminate it early.
Open-end leases used to be the industry standard, but the Internal Revenue Service has interpreted such leases with TRAC (Terminal Rental Adjustment Clause) agreements as conditional sales agreements, and they are now less prevalent. Open-end leases give you the option to buy at the end of the lease term. A provision in the tax reform bill currently pending before the Joint Committee on Taxation would make it easier for open-end leases to qualify as leases for tax purposes, allowing the lessor to take depreciation deductions and other tax advantages of ownership (see sidebar, this page).
In such a lease, the residual--or eventual resale value of a car--is set in advance. If you choose to buy at the end of the lease term, the car is yours. If you're in a strong used-car market and the car appreciates in value, you can have the lessor sell it and then you keep the difference. But if it depreciates, you owe the lessor the difference. Check current Blue Book values and compare the resale value of brands. That way, you can get some idea of which line of cars retain a high percentage of cost against resale value.
If you're looking into closed-end leases, you might try to aim for a higher projected residual price so your monthly payments will be lower. The leasing fee is based on the price the lessor puts on the car plus incidental charges and profits, so it's a good idea to compare retail car markups. The sticker price is negotiable on a lease, just as it is when you purchase a car outright. A typical lease is going to include an implicit interest rate in the lease that's generally more costly than the bank financing costs of purchasing. A leasing firm that won't pass through the investment tax credit, for instance, may be willing to negotiate the interest. Most lessors write up a lease requiring a specific lease payment each month, rather than splitting it up into interest and principal, so the deductions a purchaser makes is lost to someone who leases.
Leasing is not a tax panacea, according to Glenn Davis, the editor of Write-Off, a publication put out by the Tax Reduction Institute. But it's a convenience and a sound financial decision for many lawyers. If you're weighing the lease-versus-buy advantages, wait until the new tax bill becomes law--as it is expected to be, later this month. At that time, restrictions on depreciation deductions for expensive cars and on the personal use of a business car will be clarified. Right now, said Davis, Things are really up in the air.
Ms. Richmond is a Washington writer on the staff of Changing Times Magazine.
BUY? RENT? LEASE? HOW TO CHOOSE!
Reprinted from ALM’s Law Technology News
By Phil Shuey
Experts say technology is the third largest expense, behind real estate and staffing, in large firms; and the second largest expense for smaller firms. So what options are available to firms to help ease the financing burden?
In general, there are four primary options:
Large and mid-sized firms have options not typically as available to the small firm -- namely, capital and ability to self-finance. But this alternative may not be the most appropriate, even for bigger enterprises. If you decide to pay for technology from internal resources then, at minimum, the following must be considered:
First, is the alternate use of those funds eliminated by the purchase of technology?
Second, the creation of a sinking fund to which regular payments will be made to repay the initial investment.
Finally, the tax consequences versus other alternatives.
If you don't want to self-finance, consider these options:
Your Banks: The first source to explore is your existing banking relationships. Those relationships and a solid credit/banking history will help your firm get prompt processing and attractive financing rates.
Vendors: Ask your technology vendors if they offer in-house or affiliated organization financing. The interest rates may be attractive and there is an benefit in single source contacts, and vendor knowledge of the value of the system(s) acquired.
Rent: Renting may seem an attractive alternative in the fast-paced, changing specifications world of technology, but is a limited and expensive alternative. Renting should be restricted to ad hoc, limited duration technology needs, which do not support a long-term need or use.
Lease: Here's a simple, economical way to obtain the benefits of the latest technology without assuming the up-front costs, and risks, of ownership. The lessee pays a periodic fee, usually monthly, to the lessor for the use of the equipment. Leases are typically written contracts with specific terms and conditions spelled out: length of term, amount and timing of payments, and any end-of-lease conditions or restrictions. The lessor is usually the owner of the equipment during the lease term, but depending on the type of lease either the lessee or lessor may be able to claim the benefits of ownership for tax purposes.Regardless of which type of lease chosen, the future expected value of the equipment (the residual value) is considered when pricing most types of leases. The residual value is the lessor's estimate today of the equipment's value when the lease term ends.
Leasing is perhaps the most common choice for mid-sized and larger firms. Leasing may reduce T.C.O. (total cost of ownership) because it conserves capital, preserves existing credit lines for other needs, usually allows 100 percent financing, allows easier budgeting, may allow interim technology upgrades and offers tax advantages by expensing or capitalizing the lease payments. Naturally, in all of the financing considerations, a firm would be well-advised to discuss all final options with their accountant or financial advisor.
Ownership
Mental justification often revolves around the fact that the technology is owned by the leasing company, and that company is exposed to the risk of obsolescence, but the reality is otherwise.
Firms must first conduct a realistic needs analysis, to identify what technology may be appropriate, and identify potential vendors.
Second, a reasonable lifespan of the new system(s) should be determined. Accountants often use a three to five year justification period, but mid-sized firms would be well advised to use the low end of that range. Therefore, leasing options with a payout of 36 months will assure a realistic return on investment and payoff picture.
At the end of the lease term, the following are typical alternatives (depending on the type of lease you select): Return the equipment, sign a new lease for the most current or updated equipment, exercise a purchase option to buy the equipment or renew or extend the lease.
Few firms do not exercise the end-of-lease buy-out option. Traditionally, at the end of the term, the equipment can be acquired by a $1 or 10 percent payoff. The former results in more expensive monthly payments than the 10 percent alternative, but whatever the choice, the payoff amount should be used in the calculation of the TCO. As an example, a current published $100,000 lease with a 36 month term results in monthly payments of $3,147 with a 10 percent payoff, and $3,282 with a $1.00 payoff. A similar 36 month loan with 7 percent interest would result in monthly payments of $3088.
Remember, the vendor selected (e.g., Hewlett Packard, Dell Compuer Corp., IBM etc.) is an excellent starting place for leasing options. And their ability to remarket used systems means that they can be more competitive than other organizations. You may also want to explore other large leasing organizations.
Your choice will be dictated by the cost of the use of money, the benefits to be received by the acquisition and the best of interests of your firm.
Choose well!
Phil Shuey is a lawyer and consultant with Shuey Robinson, based in Greenwood Village, Colorado. E-mail: shueyrobinson@attbi.com.
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