Buy Versus Lease: What You Need to Know

By Jennifer Schiff | Posted July 28, 2005

When does it make more sense to buy computers? When does it make more sense to lease? Small Business Computing talked to two fast-growing small businesses, one that made the buy decision, one that decided to lease, to find out. We also spoke with executives at Dell Financial Services and HP Financial Services to find out the latest trends in small business computer purchasing and to get their take on buying versus leasing.

When your business is all about cutting-edge technology, buying can make good sense
Founded in 2000, with the current ownership taking over mid-2002, Small Business Television Network, or SBTV, is the first television network on the Web devoted to the small business market. The free service is available 24/7 on the Internet. Because of the high-tech nature of the business, having the latest technology is critical.

As the company's Chief Operating Officer, Michael Kelley, explains, "Before we went and purchased anything, we developed a business plan with a three-year outlook on what we thought we needed for the business. During the planning process, we knew that we were going to have to make a change within a three-year period [the typical length of a lease]. So that was an 'x' on the side of 'reasons not to lease,' because we new we might have to change our technology — probably in less than two years. As it turned out, it was about 14 months, and we had to make a lot of changes and reconfigurations."

Another important aspect of SBTV's decision to buy was a need to look "asset strong" to outside investors. "Our technology platform and our content are our two most important assets," says Kelley. "We didn't want to look to an outside investor as not having built our assets — the critical [components] of our corporation — correctly."

Ultimately, after weighing the buy-versus-lease decision and talking to a number of vendors, SBTV chose Dell for its servers and workstations, "because they offered us the ability to have cutting-edge technology without making a prohibitive capital investment upfront," says Kelley.

And while it paid in full, upfront, for its servers, SBTV took advantage of a 90-day, interest-free grace period for purchasing its 40 workstations, a combination of desktops and notebooks. They also took advantage of the immediate write-off allowed by the IRS, which Kelley — and many small business owners — would like to see increased.

As for words of advice to fellow small business owners, Kelley offers this: "It's very compelling to lease. But your decision needs to fit the critical values of your organization. Make sure you are not just thinking about cash flow but where you want, or need, your company to be in as little as 12 months."

When controlling cash flow is critical and you don't have time to worry about your equipment, leasing can be a great option
One of the fastest-growing wineries in California, with 80 years of experience growing high-quality grapes in the foothills of the Sierra Nevada Mountains, Delicato Family Vineyardsmay not seem like a high-tech operation, but it is.

"A lot of our operations here at Delicato are computer based," explains Michael Strohmaier, the company's director of IT. "You have the sales force that needs mobile devices and laptops. You have your front office that needs to do orders, invoicing and compliance. And then you have production that needs PCs to produce wine."

In all, Delicato employs about 200 PCs in its wine operations — a potentially very expensive capital outlay.

"The budgeting was a real challenge," says Strohmaier. He had to figure out which of their computers needed replacing, as well as determine how many new computers, and types of computers, they would need. After carefully assessing the situation, Strohmaier made the decision to lease.

Instead of worrying about a hefty upfront capital outlay, Delicato would have pre-set monthly lease payments, which "helped us smooth out our budget," says Strohmaier. "So now we have a more predictable budgeting process than we had previously. And that helps our cash flow management. Also one of the big things was reducing our risk of getting caught with obsolete technology."

Delicato chose HP as its vendor and leasing company, mainly for the outstanding customer support, says Strohmaier. HP helped Delicato set up a variety of leases, some two-year, some three-year, allowing for maximum flexibility. And while HP does offer bundled software as an option on all of their PCs (as do Dell and most other vendors), Delicato opted to just get the machines.

To date, Strohmaier and Delicato are very pleased with their decisions.

"The type of automation that we have here at Delicato gives us a competitive advantage," explains Strohmaier. "And to keep things running smoothly is very important to us. We also have a limited IT staff. And to be constantly working on fixing older PCs, that diverts you from the real goal, making great wine."

Expert advice from the experts at Dell and HP
As Keith Kendall, managing director for HP Financial Services, explains it, the buy-versus-lease rule "goes something like this: If it's an appreciating asset, something that gains value over time, then you invest cash in it. If it's an asset that loses value over time, you invest somebody else's cash in it. And since IT equipment typically loses its value over time, and in fact loses its value a lot faster than a lot of other fixed assets — like trucks or punch presses — IT assets are a prime candidate for leasing in any company, large or small."

Suneet Paul, vice-president and general manager at Dell Financial Services, concurs. "It depends on how much cash outflow you can afford upfront. Small businesses are so tied to cash flow."

That is why Paul, Kendall, and others like them in the equipment finance business makes it a point of asking small businesses what their cash flow situation is and determining whether it make sense to pay, say, $4,000 upfront or pay $45 a month over a fixed period.

Besides helping to manage cash flow, leasing can provide small businesses with obsolescence protection and a safe way to dispose of old equipment, something that has taken on increasing importance in light of stringent EPA and local guidelines for proper equipment disposal.

HP's Kendall also considers leasing a risk-management tool. "If you've invested $100,000 in equipment and it's not quite working the way you want, you don't want to invest or can't always find another $100,000 to buy another set of equipment.

"When you enter into a lease, the ability to progress from one generation of technology to the next, to expand your technology solution, to rid yourself of obsolete equipment is far easier and far smoother, because of the way a lease is structured for small and medium businesses," he says.

Currently, the most popular lease term is 36 months, typically for desktop workstations. However, many companies take out shorter leases, for 24 or 30 months, for laptops, which tend to get outdated faster and abused more.

But despite the many seeming advantages, is leasing right for you?

"What we have seen in the marketplace is a trend where the average pricing of desktop and laptop technology has been declining," says Dell's Paul. "Customers are looking for options other than traditional leasing, looking for the flexibility to do different kinds of financing. Many customers just want to pay outright or get a revolving line of credit [which Dell offers in the form of the Dell Business Credit] rather than lease."

"As the customer, you choose the equipment, software and services you need for your business," says Kendall. "What we provide is the flexibility to buy what you need, manage it financially and also manage the risk over the period of time that you use that equipment."

The tax implications of buying versus leasing
Before you make the decision to buy or lease your computer equipment, you should also carefully weigh the tax considerations. We asked a small-business accounting expert, Thomas Reynolds, a CPA and a founding partner in Ridgefield, Conn.-based Reynolds & Rowella, LLP, what small business owners should be aware of when making the buy versus lease decision.

As Reynolds explains, "There are two kinds of leases: operating and capital leases. A capital lease is basically a purchase, and all you are doing is financing the purchase through a leasing company. At the end of the lease, you have fully paid for the item, and there is either nothing due at the end, or some nominal amount, like a dollar.

"Operating leases, on the other hand, are basically a rental arrangement. You are paying for the use of the equipment over time. If you want to buy it at the end of lease term, you pay some stipulated amount, which presumably approximates fair market value at that time. Under an operating lease, you get to deduct the full cost of the lease as the lease payments are made.

"If a business buys equipment, it must then depreciate the cost of the equipment over a life defined by the IRS. For most equipment, other than passenger vehicles, that life is seven years. The cost of the asset is thus written off over that period on basically a straight-line basis (equal amount each year). However, several years ago, Congress changed the laws to allow for a special write-off in the year of acquisition. Currently, the amount of fixed-asset cost that a company can immediately write off by is $105,000. This limitation applies to the company or individual taxpayer, not to each piece of equipment.

"So in the year of acquisition, the company gets to decide whether to use the IRS depreciation life or take the immediate write off. If electing the immediate write off, the company can deduct up to the limit of $105,000, or any amount less than that limit. So if the company has $35,000 in taxable profit before depreciation, the company may elect to write off only enough to bring income down to zero.

"Leasing tends to cost the company a bit more, since the effective interest rate is usually higher. On the other hand, it is often easier to enter into a lease than to obtain an equipment loan from a bank.

"In terms of tax issues, you have the ability to write off quicker under a purchase, assuming you elect the immediate write-off. Under either a lease or a purchase, you are still writing off every dollar you spend. It's just a matter of timing as to whenyou get the write-off."

Resources
For information on Dell computers go to Dell Financial Services. You can also call 800-456-3355. For information about computers from HP go to HP Financial Servicesor call 888-277-5942.

Jennifer Lonoff Schiff writes about business and technology.

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