With Pricey Lab Equipment, Leasing May Be The Answer

Rapid improvements in the technology that is driving scientific instrument development can make some laboratory tools obsolete in as few as five years after they are purchased. And with tight budgets, some organizations, especially high-technology startups, may not have sufficient cash to buy expensive equipment outright. In cases like these, leasing equipment could be the logical alternative. The American Association of Equipment Lessors, based in Arlington, é produces several publications to help potential lessees understand the jargon associated with this complicated business. This glossary of lease-related terms is excerpted from “Equipment Leasing Is Good Business Here’s Why.” Capital Lease A type of lease classified and accounted for by a lessee as a purchase and by the lessor as a sale or a financing, if it meets one of these criteria: the lessor transfers ownership to the lessee at the end of the lease term; the lease contains an option to purchase the asset at a bargain price; the lease term is equal to 75% or more of the estimated economic price of the property; or the value of minimum lease rental payments is equal to 90% or more of the fair market value of the leased asset. Fair Market Purchase Option An option to purchase leased property at the end of the lease term at its then fair market value. The lessor does not have the ability to retain title to the equipment if the lessee chooses to exercise the pur chase option. Lease A contract in which one party conveys the use of an asset to another party for a specific period of time at a predetermined rate. Lease Rate The periodic payment to a lessor for the use of assets. Others may define lease rate as the implicit interest rate in minimum lease payments. Lessor The owner of equipment being leased to a lessee or user. Operating Lease Any lease that is not a capital lease. These are generally used for short-term leases of equipment. The lessee can use the equipment for just a fraction of the useful life of the asset. Residual Value The value of the equipment at the end of a lease. True Lease A “true lease” is a term for defining types of transactions that qualify as leases under the Internal Revenue Code so the lessor can claim tax incentives of ownership, and the lessee can claim rental payments as tax deductions. Useful Life The period of time during which an asset will have economic value and be usable. An institution’s decision whether to buy or lease equipment must be based on careful consideration of a broad range of variables, including tax consequences, the institution’s credit history, the nature of the equipment to be ac quired, and its useful life. In leasing, the lessor—a financing institution or manufacturer— invests money by buying equipment and then rents it out in a long-term agreement with a user, or lessee. Leases are analogous to loans: The sum of the lease payments plus the residual value, minus the cost of the equipment is equal to the cost of the financing. “Leasing is basically 100% financing,” says Ken Lindholm, senior vice president of MNC Leas- ing in Towson, Md. The lessor gets the depreciation benefits of ownership and the profit from leasing. The lessee can fill equipment needs without spending capital (a lease requires no down payment), count payments as operating expenses, and choose from several options at the end of the lease term. Several basic considerations determine the best candidates for leasing. A scientist working on a short-term project, for example, might want to lease rather than purchase the specialized equipment that is temporarily required. There are whole fields, in fact, where the instruments tend to become quickly obsolete—and leasing is a viable option there as well. Also, even well-backed institutions may have cash-flow problems at times, and if they buy equipment outright, they may have to lay out all or some of the money and borrow the rest. But they may not want to incur debt or diminish their available cash, and this is where leasing is a plus. When shopping for a lease, Joseph M. Grimm of Genetics Institute stresses the importance of finding a lessor that he can regard almost as a partner in the deal. This is important because a leasing relationship is not unlike a line of credit. The young Andover, Mass.-based company where Grimm is treasurer, specializes in the devel opment of blood cell growth factor, and is leasing bioreactors, HPLCs, SPLCs, and DNA sequencers. “In the last year and a half we have leased $25 million worth of equipment—not all from one lender but largely from MNC,” says Grimm. “Before that, we were leasing between $3 and $5 million, but then we started expanding and began to package larger deals. While many large institutions provide lease financing, Grimm appreciates those who have already done their homework, who know both the science and the business of a specialized field such as biotechnology. “One of the biggest factors," he says, “is the residual factor, or the amount you pay at the end of the lease. If you get someone who doesn’t understand the industry and the needs you’re talking about, the result can be an inflated residual.” Residual reflects resale at the end of a lease. The difference between the two types of leases—capital leases with fair market value residuals and operating leases with nominal residuals (10% of equipment cost)—may have substantial tax consequences. “We recently made a decision to lease $22 million of equipment, even though we had $140 million in the bank, because we did an exten sive lease-versus-buy analysis,” says Grimm. The primary advantage for Genetics, says Grimm, is that the company was able to get ‘‘leverage on their money." Leases typically run between three and seven years. Grimm says Genetics Institute has chosen longer leases. For a lease with a full market value residual, the longer the term, the lower the payment at the end. The leasing term is not the only point of a lease that can be negotiated with the lessor. Other negotiating points, which should be discussed with a lawyer, include the rate, or amount of monthly payments; the structure of the lease (capital versus operating); the purchase option; and the renewal option. Upgrades are always negotiated with the lessors. Some leases may include phrases that allow for trading in equipment, adding the cost of an upgrade to the agreement, or possibly even terminating the agreement. Termination is usually only allowed after a certain amount of time and usually not without a penalty. Leases rarely include any services beyond financing. Maintenance and insurance are almost al- ways the responsibility of the lessee, Lindholm notes. Options at the end of leases vary greatly depending on the agreement. Lessees may buy the equipment, renew a lease on the same equipment, upgrade the equipment and renegotiate the terms, trade the equipment in for new, or simply return the equipment. Another option, particularly for startup companies facing a serious capital crunch, are leases that include equity agreements where the lessors receive not only cash, but stock as payment, notes Barry Bronfin, president of Financing for Science and Industry in Hartford, Conn. “The current trend by lessors is to approach the lease like a venture capitalist,” says Bronfin, who has an Sc.D. in chemical engineering. If you’re interested in leasing, first talk to an accountant about the tax and financial consider- ations. If together you decide that leasing is the best option, then figure out what equipment you need and how much it should cost. Finally, talk to a lawyer experienced in leasing. Both lessors and lessees stress the need to fully understand a lease’s very specific terms before entering the agreement. A novice should not attempt to negotiate a lease without legal counsel. Clarice Wood is a freelance writer based in Denver, Colo.

With Pricey Lab Equipment, Leasing May Be The Answer

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