What is an Equipment Lease Agreement

Legal Article

What is an Equipment Lease Agreement

Buying and maintaining equipment is expensive. Further purchasing equipment can also be stressful, as technological innovations are leading manufacturers to come out with newer models of machinery every few months or years. Thus, unless you purchase your equipment at the optimum time, your competitors could soon purchase the newer equipment model and have an advantage over you. Due to the cost and stress involved in purchasing business equipment, small businesses are increasingly choosing to rent machinery.

Equipment leasing refers to a type of financing where a business rents critical equipment rather than purchasing it. The most common types of equipment businesses lease include machinery, vehicles, computers, and other tools that may be specific to certain industries. Like other kinds of leases, the businesses will rent the equipment for a specified period of time and once the lease term is up, the business can choose to renew the lease, purchase the equipment, or stop the agreement.

Benefits of Equipment Leasing

As with anything, all leases are not made the same and will contain different leasing terms and pricing. However, below are some of the largest benefits a business can gain from choosing to lease instead of purchase equipment.

  • Most equipment lease contracts will not require a significant down payment.
  • Because your lease only lasts for a specified period of time, you can constantly upgrade your equipment.
  • If you need to upgrade or add more pieces of equipment as your business grows, you can do so without having to sell off your older equipment and spend the time searching for replacements.
  • In most cases, you may receive tax credits for leasing equipment. Section 179 Qualified Financing allows you to deduct your payments as business expenses.

Types of Equipment Leases

There are two main categories of leases: capital and operating.

Capital Lease

A capital lease is normally used for non-cancelable long-term equipment leases where the leasing company is considering purchasing the equipment when the lease ends. In this type of lease, the lessee must maintain the asset and pay for any taxes or insurance on the equipment. Further, the assets and liabilities of the equipment are recorded in the leasing companies balance sheet. The most common reason why a business would prefer this type of lease is for expensive equipment that the business may not be able to purchase immediately.

Operating Lease

Companies that are looking for short-term and possibly cancelable leases will normally opt to use an operating lease. Additionally, this type of lease is optimal for businesses that want to use the equipment temporarily. It is also useful for companies that definitely know they will replace the equipment at the end of the lease. In operating leases, the owner of the equipment retains ownership of this property. Because the lessor retains ownership of the equipment, the lessee can usually terminate the lease at any time without penalty.

Components of an Equipment Lease Agreement

Like most contracts, an equipment lease has a few required pieces of information. Below are the common components of equipment lease agreements.

Lease duration

While the lease duration is vital for every equipment lease, the duration of the lease can be modified to fit the needs of both parties involved in the transaction. Most small businesses may opt to utilize shorter lease durations as they may experience fluctuations in business that could make the lease impractical. Additionally, businesses that are planning to lease expensive capital equipment will normally choose a longer lease duration as the longer the lease term the cheaper the monthly payment will usually be.

Financial terms

The financial terms will state timelines on payments and the penalty if the lessee misses a payment.

Market value of equipment

Most of the equipment companies will lease is extremely expensive. Knowing the cost of the equipment before agreeing to a lease can help the lessee figure out how expensive it will be to obtain insurance for the equipment.

Tax responsibility

Depending on what lease is utilized, the lessee may have to pay taxes on the equipment. Similar to knowing the market value of the equipment, figuring out the tax burden on equipment will help lessees understand if they can afford the lease.

Cancellation provisions

One of the most important clauses to include in an equipment lease agreement is what happens if the lessee backs out of the lease. The most common reason why a business may decide to cancel an equipment lease is that they cannot afford payments or because the equipment is outdated or defective. As some leasing companies will charge punitive penalties for canceling the lease early. Thus, it is important for both parties to understand what happens if the lessee backs out of the agreement.

Lessee renewal options

This provision states the process for renewing the lease after the initial lease term is over. This provision is useful for the lessees as it will allow them to negotiate a lower payment. This can also give them an option to buy the equipment.

How to Finance Equipment Leases

Leasing equipment more financially feasible for small businesses. However, for some businesses, they may still need to finance these transactions. Below are the three most common ways small businesses finance equipment leases.

  • Leasing companies: There are a variety of leasing businesses that all offer different services, leasing terms, and product quality. As leasing companies can have significant differences, a small business owner should compare multiple leasing companies’ terms. Finally, leasing companies are a relatively new kind of company so businesses should do background checks on companies they are considering using.
  • Banks or traditional lenders: Most banks offer loans or advance credit to small businesses looking to lease equipment. As banks charge relatively low-interest rates, they are the most common lenders for companies looking to lease equipment.
  • Equipment dealers and distributors: Most equipment dealers own subsidiary companies that offer loans for equipment leases. While these companies can be a viable option, you should compare loans with banks or outside leasing companies before committing.

Final Thoughts

With technology advancing faster than ever before, while also increasing substantially in cost, more small businesses are choosing to lease instead of purchase important business equipment. Because more businesses are choosing to lease equipment, there are now thousands of companies that offer equipment leasing options.

Contact Our DC Law Office for More Information

Finally, for more on what are equipment lease agreements, contact us at 202-803-5676. You can also directly schedule a consultation with one of our skilled attorneys. Additionally, for general information regarding business law, check out our blog.