Equipment Leasing Agreement: Types and Key Terms
If you’re a business owner hoping to expand your range of products and services, then you might be looking into acquiring new equipment. Unfortunately, most industrial equipment can be expensive, which makes it hard to pay for them up-front and in-full from out of your pocket. So what options do you have?
Before you take out a loan, you might want to consider an equipment lease. This type of agreement lets you ‘rent’ a unit of equipment for an agreed term. They can be flexible, more affordable, and ideal for business owners in certain situations.
Is an equipment lease agreement better for your venture? Here are some specifics worth knowing.
Types of Equipment Lease
- Capital / Finance / Dollar-Buyout Lease – This type of equipment lease agreement lets you use the equipment in question for a period of time. During the period, you pay for the use of the equipment. At the end of the contract, you’re issued an option to purchase at a nominal price of the equipment after the loan term.
- True / Operating / Service Lease – These are often shorter lease types, and will last for less than 75% of the equipment’s anticipated useful life. The monthly payments are computed based on the equipment’s fair market value (FMV.) In effect, a lessee should not pay more than 90% of the equipment’s FMV. These lease types are often more affordable than most, and the cost for the lease will not show on the lessee’s balance sheet, representing the equipment as an ‘operating expense.’
- PUT Lease – Purchase upon termination or PUT lease agreements basically require the lessee to purchase the equipment after the lease term. The cost of purchase will be pre-determined, before the agreement is executed. In effect, a PUT lease will give you far cheaper monthly since the lessor can do without the risk of being uncertain as to what happens to the equipment when the lease contract ends.
- TRAC Lease – A terminal rental adjustment clause lease or TRAC lease is a type of agreement that’s used for over-the-road vehicles. Parties decide on the residual value of the equipment being leased, and the monthly payments are computed based on that cost. The higher the residual value, the lower the monthly payments and vice versa.
- Sale and Leaseback – If you already own a piece of equipment, a sale and leaseback agreement lets you sell the equipment to another entity, and then lease the equipment back for a long period of time. When executed, the sale and leaseback agreement allows you to use the equipment without owning it.
Key Terms for Equipment Lease Agreements
- Buyout – The value that the lessee must tender in order to terminate the lease contract before the end of its term. This will usually pay for unpaid taxes, other fees, and a portion of the lessor’s lost revenues.
- Close end lease – Types of leases where the lessee is not obligated to purchase the equipment after the contract duration.
- Early purchase option – A predetermined value that a lessee can issue at any point in the lease contract in order to purchase the equipment.
- Estimated useful life – The length of time that an equipment is expected to be useful or beneficial.
- Fixed purchase option – An option granted to the lessee to purchase the equipment at the end of the contract, usually represented by a percentage of the original purchase cost.
- Default – This happens when a lessee fails to meet the requirements stipulated in the lease contract. If a lessee defaults, the lessor reserves the right to exercise the agreed penalties, from fines to repossession of the leased equipment.
- Depreciation – Represents the loss of an equipment’s value secondary to use, wear and tear, and the release of newer, updated models that might make the original equipment obsolete.
- Fair market value – An estimate of the value of a property or equipment based on the knowledgeable agreement of both lessor and lessee.
- Interest – The amount or cost applied by the lessor on the lease cost which serves the purpose of profit or revenue.
- Lease commencement – The date when the lease agreement is executed, evidenced by an execution of a contract.
- Lease term – The period of time when the lease agreement will be in effect.
- Lessee – The lessee is the individual or business owner seeking to lease an equipment to support business functions and operations.
- Lessor – The individual in possession of the equipment being leased. The lessee makes payments to the lessor in exchange for the use of equipment.
- Level payment – Used to describe monthly payments that are the same every month, all due on the same day of each month.
- Nominal price – Nominal prices represent the dollar value of a property or equipment on the date it was produced.
- Open end lease – A type of lease agreement where the lessee agrees to pay a certain amount to the lessor at the end of the lease term to purchase the equipment in the contract.
- Residual value – The cost of a property or equipment after the lease term, usually expressed in a percentage value of its original price.
- Renewal option – A stipulation in the lease agreement that states that the lessee can extend the lease beyond the original lease term.
- Security deposit – An amount of money issued by the lessee at the beginning of the lease contract, typically the sum of two lease payments. This value is held by the lessor as a ‘security net’, should the lessee terminate the contract before the end of the term. If the lessee is able to complete the loan term, the lessor will use the security deposit to pay for any damages and repairs necessary to restore the optimal function of the equipment. Any residual amount left behind after the repairs will be returned to the lessee.
- Useful life – The period during which the equipment being leased can be used for its purpose or benefits.