Leasing vs. financing: What’s the difference?
Purchasing new hardware or software can be a costly and burdensome investment for even the most profitable organizations. But purchasing outright isn’t a company’s only option. Organizations can lease hardware and finance software and maintenance to ease upfront costs and increase IT flexibility. So before you sign that check for your next big order of desktops, servers, or software, see if any of these options are right for you.
The two types of hardware leasing
Leasing is the most common way to acquire IT equipment without paying for it up front. There are two main types of leases: the fair market value (FMV) lease and the $1 buyout lease.
The most common type of hardware lease is the FMV. It’s similar to a car lease, in that you don’t own the product at the end of the term, which is typically two to three years. In an industry known for a 36-month product lifecycle, this is a compelling benefit. The greatest part of IT is that the power keeps going up and the price keeps going down. FMV leases offer the lowest payment option since you’re only paying for the use of the product, not the purchase price. Payments are usually referred to as rent.
FMV leases give the most benefits to the lessee — the user of the equipment. These benefits include capital management (using your cash flow properly), financial performance (including financial ratios such as current ratio, quick ratio, and return on assets), taxes (such as the distribution of sales tax over the lease term), technology (productivity gains associated with new systems), and flexibility. You’ll reap technology benefits whether you are leasing a Toyota Camry or an i7 notebook, but the pace of change in IT is much faster than in the auto industry, making the benefit more prominent. And the notebook rents for only $1 per day!
Flexibility is probably the biggest benefit. It’s hard to quantify, but can be significant. The ability to do something sooner rather than later can be a game changer.
For example, years ago, a fast food company outfitted its regional managers with notebooks so they could meet with store managers on-site to measure performance. Meanwhile, at headquarters, the company was developing new software to support the operation. But they realized late in the game that the software would not run on the field notebooks. Luckily the notebooks were leased, so the company was able to return them a year early and roll out new notebooks for about the same payment it had on the first batch. If the company had owned the notebooks outright, it would have either had to wait to roll out the new software or take a huge loss on the first group. Flexibility is key.
In addition, an FMV lease has more options at the end of term. Lessees can:
- Return some or all of the equipment to the lessor (the party renting out the hardware). This is the most common option.
- Continue to rent the systems for a couple extra months while you decide on their replacements.
- Extend the lease for six months or more at a lower payment.
- Purchase the equipment at the current fair market value.
$1 buyout lease
The second type of leasing is the $1 buyout, also known as a set price buyout. Going back to the car analogy, the $1 buyout is more like a car loan. Payments are spread out, and then you own the asset at the end of the term. This method has some benefits but not as many as the FMV option.
The $1 buyout is called a lease, but you actually finance the purchase price.
An added bonus: $1 buyout leases are eligible for the Section 179 tax deduction, which lets you write off the full purchase price of the technology leased, up to $500,000, without actually having paid the full amount. In some cases, the amount saved from this deduction exceeds what you might have spent on payments for the year, yielding you a profit. Qualifying financed or leased equipment and software might change on a yearly basis, though, so check with your tax advisor to see if you qualify.
While leasing is the typical payment option for hardware, financing is often the preferred method of payment for software and maintenance. The typical length of a financing agreement is three years. It’s not a lease because you own the software license on day one, despite the purchase price not being fully paid. Think about it. If a software agreement is $3 million for three years, would you rather pay $3 million up front or $1 million a year for three years? Probably the latter. This type of program is called a simple installment payment agreement (IPA).
SHI offers both hardware leasing and software and maintenance financing options to organizations looking to upgrade their IT infrastructure. And by working with us, the largest minority and women-owned business enterprise in the country, you’re eligible to earn minority spend tax credits on your investment. Ask your SHI representative if any of these payment plans are right for you.