Affordable IT: Leasing IT Equipment

IT infrastructure costs can easily shrink or sink a budget. Leasing equipment might be your best bet. We show you the pros and the pitfalls.

May 18, 2006

13 Min Read
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It's hard to imagine running a business without some sort of technology infrastructure, but the capital expenses can be prohibitive for small and midsize companies. Consider leasing new equipment.

Budget-conscious IT managers can conserve capital and simplify bookkeeping by making set payments over time rather than in one lump sum. They also can upgrade equipment at regular intervals without breaking the bank and shift the burden of proper environmental disposal to the lessor. Depending on the contract, the lessor also may assume liability for sensitive data that might inadvertently remain on hard drives.

Today's IT customer expects a high degree of technological sophistication, driving increased IT spending that's disproportionate in small businesses compared with that of the bigger fish. "Ten years ago, a PC and an AOL account was sufficient for small businesses," says Joseph Pucciarelli, research director, Technology Financing Strategies, at IDC. "Now there's an expectation to have a Web site and be able to buy a product online." That requires a more robust computing infrastructure.

About 40 percent of small and midsize businesses take advantage of financing options (including leasing, bank loans and credit cards) to acquire computing infrastructure compared with about 20 percent of the enterprise segment, according to Pucciarelli.Hardware manufacturers such as Dell, Gateway Hewlett-Packard and IBM have set up their own financing arms or partnered with third-party financing companies to facilitate leasing. Working with regional and local leasing firms also is an option.

To determine if leasing is right for you, do some legwork. Speak with lessors to find out which has the best combination of financial plans and equipment. A large, brand-name lessor may include stock switches or firewalls in addition to PCs and servers. And decide which kind of lease best fits your needs. The plan you choose will affect your monthly payments and the final cost of any equipment you decide to purchase.

New Lease on Life

Leasing Tips

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Leases are generally divided into two species: Fair Market Value (FMV) and Lease-to-Purchase (LtP, also known as a payout or buyout lease). Knowing your long-term plans for the leased equipment will help you choose an option with the most suitable outcome.The specifics of each kind of lease vary depending on the lessor, but all follow a basic structure. The FMV plan lets you borrow the equipment, usually for two or three years. At the end of the term, you can renew the lease or return the hardware in exchange for new systems. The FMV plan means a lower monthly payment than an LtP plan. It allows for perpetual technology updates and removes the burden of safe equipment disposal. At term's end, your IT staff must prepare the existing hardware for return and swap in the new hardware--with all the attendant problems such as OS and app installation, configuration and so on. Failure to adequately prep for the hardware swap could cause downtime and lost business, or additional fees from the lessor.

If you want to buy the equipment, as the name implies, the FMV plan will let you pay fair market value. However, that amount depends on the type and age of the system and its components. Ask your lessor who determines value. In some cases, your total payout, including lease payments and the current market value, may be near or equal to the original equipment price, but beware--you could end up paying more.

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The LtP plan is a loan from the financing organization: You make monthly payments with the intention to purchase the equipment at the end of the lease term. Most lessors offer a $1 purchase at term's end, but they may have other options. Gateway lets you buy the equipment for 10 percent of the original cost, for instance. The $1 plan and 10 percent plan will result in different monthly payments and purchase costs, so many lessors provide online calculators to help estimate these factors.

The LtP plan may offer better financing than a bank loan or a credit card purchase. This option is useful for equipment that will have a life span of five or more years. You also don't have to go through the time and effort of shipping the system back to the lessor. The downside: Monthly payments will be higher than an FMV plan, and you may have to pay an additional sum at the end of the term to complete the purchase. You also risk having obsolete technology on your hands at the end of the lease and having to pay to dispose of it properly.There's about an even split between leasing customers that buy the product at the end of the lease and those who swap old hardware for new, according to Bryan Spence, director of business development at LEAF Financial, which partners with Gateway to provide financial services for leasing clients.

Multiple Benefits

Leasing offers three advantages: financial flexibility, protection from obsolescence and simplified equipment disposal. Financial flexibility is a core driver. First, leasing is often cheaper than buying equipment outright. For instance, according to IBM Global Services' leasing calculator, the total payments for $50,000 worth of equipment comes to $45,360 under a Fair Market Value lease of 36 months (see the table on page 59).

Then there's the flexibility. You'll be better able to manage your cash flow by making fixed payments at regular intervals. And a leasing contract may be less complicated than a bank loan and offer better terms than a credit card, not to mention more buying power. Lessors often allow a variety of invoicing options, from monthly to annual, which may be appropriate for businesses that earn a substantial portion of their revenues during holidays. You might be able to negotiate an increase or decrease in payments if you find yourself with extra cash on hand or are experiencing a shortfall in business. "We listen to the customers' needs and try to structure a deal," says Ken Hall, director of finance at Gateway.

Ask your finance department and tax adviser if leasing will provide a tax advantage compared with paying cash or choosing other financing options. Some types of leases let you take a tax deduction for the payments.The second major benefit is the regular equipment upgrade. Leasing customers protect themselves from obsolete technology because they will swap out old systems for faster, better-performing ones. PCs are a prime example: Memory and processing speed increase every year, while new features, such as built-in wireless radios that support the latest standards, are rolled out.

A general rule of thumb says to replace laptops and servers every three years and desktops every three to four years. Gartner suggests keeping some desktops even longer, depending on the use case--for instance, employees who require only basic Office applications. Network hardware such as switches and routers likely won't be replaced as often, unless you need to upgrade to faster speeds, improve port density or support the latest protocols and vendor features.

Older computing equipment, like older cars, tends to require more maintenance, which increases the cost of ownership. You can avoid these costs by swapping out old equipment for new. In addition, you can structure the lease term to match the equipment's warranty period. If you have a three-year server lease and those servers have a three-year warranty, for example, your basic maintenance costs are covered.

Of course, how long you keep equipment will be driven by the particulars of your business. "Companies that use their computing infrastructure more aggressively may find more value from leasing because they would have business value from regular replacement," says IDC's Pucciarelli. "Consider an architectural firm doing 3-D CAD drawings and using complex software--architects can't architect if the computers aren't computing."

"Technology turnover drove us to leasing more than anything else," reports Allan Camous, systems engineer at Ranger American, which installs home security systems. "Every time we made a large purchase of equipment, three or four years later we had to rip it out," he says. Now Ranger American swaps out old desktops and PDAs for new ones every three years.The third benefit of leasing is that by returning old equipment to the leasing company, you avoid the regulatory burdens for proper equipment disposal, which includes wiping drives that may contain personal data, as well as meeting local or state environmental directives for disposal. Leasing companies often partner with third-party disposal companies to erase hard drives and either refurbish used equipment for resale or meet the requisite guidelines for throwing it away. Ensuring that sensitive data doesn't leave the enterprise on old hardware is essential. At present, the rules regarding data loss and disposal--and the resultant punishments--vary by state, but companies that fail to properly handle sensitive data also risk losing customers and being sued. Even if the lessor is responsible for sanitizing hard drives, prudent IT professionals will wipe hard drives to prevent mishap.

According to the Environmental Protection Agency, discarded business computers may be considered hazardous waste as they may contain PCBs and lead. Several states, including California and Massachusetts, have made it illegal to dump computer equipment in landfills.

"Whatever regulatory requirements there are today for data leaks and environmental issues, three years from now there will be three times as many," says IDC's Pucciarelli. "Having a third party manage that part for you isn't a bad thing."

Of course, returning equipment to the lessor isn't the only option. If you own the equipment, you can also shift the disposal burden to another party by selling old equipment or donating it to a charitable organization. And the market value of donated equipment may qualify for a tax write-off. However, you will still be responsible for removing sensitive employee or customer data before it leaves your hands.

Watch Out for PitfallsLeasing may be more expensive than a cash purchase if you plan to buy the equipment at the end of the term. You're either paying interest or the market value of the equipment, in addition to the original purchase price. For instance, using the IBM Global Services loan calculator, a $50,000 equipment purchase under a 36-month LtP contract will actually cost $54,000 ($1,500 per month), which comes out to 8 percent interest. This rate may be lower than a credit card or bank loan, but it is certainly higher than paying cash up front. (However, with a purchase, you'd lose the use of the cash, which could justify the incurred interest payments.)

The final purchase price may be even higher under an FMV lease, in which you must pay the current market value for the equipment if you choose to purchase it at the end of the term. As mentioned previously, the total lease payments for $50,000 of hardware under an FMV lease came to just over $45,000. If the current value of the equipment is over $5,000, your final cost will be greater than if you had purchased the equipment outright.

You can get a general sense of market price by checking eBay or other online sites but, depending on the contract, the equipment vendor may be the one to determine that value--based on their own calculations or that of a third party. "If it's solely at the discretion of the leasing company, [it] may not be fair. There ought to be some healthy dialogue," Pucciarelli says.

If you don't end up buying it, of course, you're going to lose it at the end of the term. "Every three years they expect to have that stuff back," says Ranger American's Camous. "It's not an easy thing to replace a server, especially one that's handling a lot of important stuff. Some of our servers had passed the leasing due date and we had to scramble to get [the equipment] back to them."

Ranger American bought several servers at the end of a lease rather than return them because it would've been too disruptive to pull those machines out of production and then install new servers. "With high-end servers, there's no need to change everything every three years," Camous says.Potential leasing customers should try to anticipate how long they might want particular kinds of hardware, according to Gateway's Hall. "If the equipment is going to meet their needs for five years, leasing might not be for them. If they enter into a 36-month lease but will keep it for five years, it defeats the purpose of having a lease as a hedge against obsolescence," he says.

If you lease equipment, you will be responsible for repairs that fall outside the warranty. Typically, the cost of a maintenance agreement can be included in the lease, but will likely raise the monthly payments. Be sure to discuss warranty and maintenance issues with your lessor before signing a contract.

Cash or credit purchases will put the equipment in your hands right away, which is often not the case with a lease, particularly if you're just establishing a relationship with the lessor. The leasing company will require a credit approval process, and you'll also have to negotiate terms and conditions of the lease. This may add days or even weeks to the delivery of actual product.

"With some leasing companies, it could take four to six weeks to get the ball rolling," Camous says. "You order a piece of equipment from a manufacturer, and then you call the leasing company and go through a credit routine every time, and send them an earnest payment just to get the lease going."

You also have to account for which equipment must be returned by which date, which equipment you intend to purchase and so on. Failure to return equipment on time may result in penalties or fines. Some lessors, such as Dell, offer a Web interface to help you manage your contract. You're also responsible for any equipment that's lost or stolen.Finally, ask about fees or penalties that may be triggered if you fail to meet certain requirements of the lease, such as failure to return equipment on time.

While leasing might not be the perfect solution for everyone, it can be just the right fit for the small or midsize business with a limited IT budget.

Andrew Conry-Murray is Network Computing's business editor. Write to him at [email protected].

Executive Summary

IT managers at small and midsize businesses struggle to find funds to purchase or upgrade computer hardware. If you're looking for ways to stretch your IT dollars, leasing is a viable option. Not sure if leasing is right for you? We show you the advantages and pitfalls to doing business on rented time.The two common lease types are Fair Market Value and Lease-to-Purchase. The Lease-to-Purchase plan is essentially a loan to buy equipment over a fixed term. The Fair Market Value plan offers lower lease payments and lets you buy your equipment at the end of the term for used prices, but beware that you could still end up paying more than just buying it outright. Both options offer upgradability without the big, one-time hits for equipment purchases. Leasing also may provide unexpected tax write-offs that will make your CFO happy. Add a transition plan to return equipment at the end of the lease, and you could truly get the best of both worlds--without tanking the budget.

You can find all our Affordable IT articles here.

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