Lease education and consulting by
Vinod Kothari
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Lessee motivations in Leasing:
Why should a lessee at all be interested to lease in? The motivations cited below are generic - some of these are applicable to financial leases, and some to operating leases, and some to both. As matter of fact, what a lease has to offer to the lessee is dependent on whether it is a financing alternative or an alternative mode of acquiring the asset.
- 100% financing frees working capital for more productive use
: Generally, though not necessarily, leasing is 100% funding - the lessor buys the equipment and leases to the lessee. In lending, it is most common for the lender to insist on the borrower's contribution by a margin. Click here for more on why leases do not provide for a margin as such. 100% funding is not always recommendable from the lessor's prudential viewpoint - therefore, it is common for the lessor to insist upon an upfront payment either as a security deposit or as initial rentals.
- May cost less than other methods of acquiring equipment: Leasing as a method of acquiring capital assets may cost less than other alternatives available. A lessor might affordably price a lease cheaper to other alternatives either if his own cost is appreciably low, or if the lease confers incremental tax benefits to him and he values the same more than the lessee does. The first reason is rarely likely to be true; hence, if lease plans are cheaper than borrowing, they are mostly because the lease is oriented towards lessor's tax shelter.
- Flexible, fast and negotiable : Leasing is generally believed to be more flexible than any other method of financing. A leasing plan can always be tailor-made to suit the requirements of the lessee. Other traditional forms of finance are not seen having this advantage. It is important to realize that speed, flexibility or negotiability are features of an entity offering a financial plan, rather than those of the plan itself. So, it is not that the lease plan is more flexible than a loan plan: it is mostly the lessor who is more flexible than the lender. Though the distinction is being eliminated very fast, it is possibly due to the fact that the lessors operated in a less-regulated, more proprietary environment than bankers or traditional lenders, or perhaps, because being a comparatively new development, lessors had to be fast and flexible, to claim this as their unique selling proposition.
- Increases the borrowing capacity of the lessee: There are at least 3 ways in which leasing can increase the borrowing capacity of a lessee:
- The credit rating of the lessee made by the lessor is often less strict than that done by banks or lenders. This is probably because the lessor maintains title over his assets. The immediate gains the lessor makes on tax benefits might be another reason for him to be more lax.
- It helps to maintain low the Debt/Equity (D/E) ratio of the lessee so that this borrowing capacity is kept intact even after the lease-financing has been done. A lease-obligation is not recorded on the Balance-Sheet of the lessee as a debt [this is subject to applicable accounting standards] As such, it does not affect the Debt-Equity (D/E) ratio of the lessee.
- One can borrow more having a mix of financing methods rather than by relying on one source.
- Off-the -Balance-Sheet means of finance : As discussed already, lease obligations do not appear as a liability on the Balance Sheet of the lessee (subject to applicable accounting standards), which keeps the lessee's debt/equity ratio low. This ultimately also improves the return on investment (ROI), as his operating incomes increase but the net-block as appearing in the balance-sheet remains unchanged.
- Tax benefits: Leasing may permit a more rapid amortization of the asset than would be permissible under the depreciation rates applicable in case of an owned assets. When an asset is owned by the lessee, the only method of writing its cost off is depreciation, which would essentially depend upon the nature of the asset and the permitted depreciation system. On the other hand, as lease rentals are fully tax-deductible, they will write-off the cost of the asset (represented by the principal repayment inherent in rentals) in the lessee's books over the lease period -say, 3 years. There are front-end loaded leases (that is, where rentals are high to begin with and reduce over time) which write-off as high as 50% of the cost in the very first year.
- No coercive covenants : Loan agreements with banks usually contain coercive conditions such as restrictions on transfer of shares, issue of bonus shares, right to appoint nominee directors, convertibility clause, etc. Leasing companies are not known to have imposed such restrictions, except in case of venture funding.
- Hedging against risk of obsolescence : One of the most notable merits in case of operating leases is that the lessor bears the risks of obsolescence. Likewise, the lessee is saved of the trouble of having to dispose of the asset he is not using - by simply returning it to the lessor.
- Expert advice on selection of equipment: Though a pure financial lessor would not like to embroil himself in selection of the equipment, a more proactive lessor, and certainly an operating lessor, is a great source of advice in selection of the equipment - the lessor's regular association with an asset of a particular specification makes him qualified to assist the lessee.
