In our last blog, we covered two of the five most common types of equipment financing: a Dollar Buyout Lease & a Fair Market Value Lease.
Here in part two of our ultimate guide to equipment financing we are going to cover three more very common types of equipment financing:
- Fixed (or Stated) Purchase Option Lease
- Early Buyout Option Lease (EBO Lease)
- Seasonal Payment Lease
As we dive into the details, here’s what you’ll learn:
- Detailed explanation of each financing option listed
- Pros (or positives) of each type of lease
- Cons (or negatives) of each type of lease
Let’s jump into defining each type of lease first.
What is a lease with a fixed (or stated) purchase option?
Quite simply, a lease with a fixed purchase option gives you an agreed upon and stated purchase price at the time you sign the lease. This lets you know what the buyout price will be at the end of your lease before you sign it. You can probably already guess what some of the “pros” are based on that explanation, but let’s take a deeper look anyways!
Top 3 Benefits (or Pros) of a Fixed Purchase Option Lease
1. A lease with a fixed purchase option means you agree to the buyout price with the lessor BEFORE you sign the agreement, which allows you to project your financials throughout the terms of the lease… as well as at the end (something that many executives may have anxiety over with a Fair Market Value Lease).
2. The bank or lessor will make a residual assumption on the equipment, which means, as stated above, you’ll get lower monthly payments with a fixed purchase option lease than a $1.00 Buyout Lease.
3. Usually, with a fixed purchase option that is high enough, you can fully expense the lease payment as an operating expense which can help with tax minimization.
As you can see, these are some pretty compelling reasons you might consider this type of lease versus some of your other options, but it does come with its own set of downfalls as well.
Cons of a Fixed Purchase Option Lease
- It’s obvious, but the buyout at the end of a Fixed Purchase Option Lease = Increased financial pressure compared to a $1.00 Buyout Lease.
- If the equipment has depreciated/lost value very quickly then you may have been better off with a pure FMV lease because you would get the lower Fair Market Value at the end.
- You (usually) cannot take the depreciation expense like you could with a $1 buyout lease.
Now that we’ve accurately covered the typical pros & cons of a fixed or stated purchase option lease, let’s jump into the details of an Early Buyout Option lease.
What is an Early Buyout Option Lease?
A lease with an early buyout option usually has a fair market value at the very end of the lease (almost always), but there is an early buyout option. An early buyout option gives you the ability to buyout the equipment for a set amount prior to the end of your lease.
So let’s look at an example on a five year lease. At the end of four years, there might be an early buyout option of say $200,000 or $300,000, and you could activate that early buyout instead of waiting to the end of the lease and paying the fair market value for the equipment.
How does this help you? Well, let’s look at a few reasons why you might like this type of lease.
Pros of an Early Buyout Option Lease
1. Avoiding Fair Market Value – If your equipment holds its value really well you can activate your early buyout to avoid a potentially high fair market price.
2. Financial Planning – If you know what your early buyout price will be, you’ll have better foresight with the EBO price in mind while planning your budget down the road.
3. Residual Assumption – Just like an FMV lease, your leasing company such as IFSC, will make a residual assumption on the equipment value, which ensures a lower monthly payment.
As always, there ARE trade-offs for every type of financing. Here are two key things to consider with an early buyout lease.
Cons of an Early Buyout Option Lease
1. If you choose not to activate your early buyout option, you could get stuck paying the fair market value price. Which could end up being A LOT higher than your EBO agreement if your equipment holds its value really well.
To see more about the possible negatives of paying FMV, here’s a link to my recent LinkedIn post about it: bit.ly/negatives-fmv
2. In addition to activating the EBO agreement, you MUST REMEMBER to activate it within a certain period prior to the EBO date (usually 6 months before the EBO date). If not, you’ll miss the EBO opportunity and be locked into the FMV.
So make sure you know that date and have it written down somewhere. It’s probably even a good idea to mark it on the calendar!
What is a Seasonal Payment Lease?
Seasonal payment leases are mostly self-explanatory. They offer an option to make payments seasonally rather than every month of the year. Because seasonal businesses like golf courses, ski resorts, amusement parks and traveling carnivals only have positive cash flow at certain times of the year, banks will usually not want to take on the risk of a seasonal business.
Here are some core benefits of a seasonal payment lease.
Pros of a Seasonal Payment Lease
1. You don’t have to make payments in your off-season
2. You may not need a line of credit in your off-season
3. At IFSC, you don’t pay anything extra for seasonal payments
If you are a seasonal business and only want to make payments during times of cashflow, this is a perfect option for you (shameless plug!)
Now, we have to follow the theme of the post and write about the cons of seasonal payment leases, right?
Well, that’s a tough one, because there really isn’t much negative to write about here! These loans are perfect for seasonal businesses. The only potential negative is that you typically can’t go to a bank for one of these.
Hopefully this gives you a thorough idea of your equipment financing and equipment leasing options! There are a plethora of alternatives. While these blogs have hopefully given you a great idea of what to look for and watch out for, you may still want to discuss the options with an industry professional.
IFSC has been a non-bank equipment finance provider since 1981. If you are in need of financing for your next big project please click here to apply.