Should You Buy or Lease Your Small Business Equipment?Experts explain how to figure out which choice is more cost effective and tax friendly.
According to the U.S. Census Bureau, businesses in the United States spend more than $900 billion annually on equipment — everything from computers to stoves to X-ray machines. You can’t run your small business without it. But should you buy or lease? Making the right decision can save money and even help you grow you business.
“The most important decisions made by small business owners is deciding what equipment will power the operations,” said Joe Kennedy, principal of QB-LA, an accounting and financial reporting firm in Los Angeles, California. “But what many owners don’t realize is that the second most important decision is how to pay for this — purchase or lease.”
Experts shared the pros and cons of each option to help you make the right decision.
Purchasing pros and cons
“The main advantage to owning your equipment is that, you own it,” said Vernon Tirey, CEO and co-founder of LeaseQ, an online marketplace that connects businesses, equipment dealers and leasing companies. “If you purchase your equipment, just like when you pay cash for a car, it’s yours, and you don’t owe any interest or fees to the bank.”
- Lower overall cost. “Outright purchases often result in the lowest overall cost for acquiring business equipment,” Kennedy said.
- Permanence. If you expect the equipment to become a permanent part of the business operation, owning it may be your best option.
- Ability to customize or modify. If you need to alter the equipment to meet your needs, you need to own it.
- The ability to swap. If you need to upgrade or swap equipment for a new or different version later, owning may be your best choice. Swapping for newer equipment is generally not allowed in a lease agreement.
- Tax deductions. When you buy, you may deduct depreciation from your taxes.
- Greater selection. If you’re buying, you have any option you can afford. When leasing, you may be limited to the stock on hand.
- Collateral. Business equipment you own may be used as collateral on new loans for your business.
If you decide you want to own your equipment, your next decision will be whether to pay cash or finance the purchase. “This decision can have major financial consequences, and it’s usually worth the cost of having your CFO or an outside financing pro run the numbers and figure out the best options,” Kennedy said.
Cons of purchasing include:
- Maintenance. “Businesses that operate equipment that is important to the core operations of the firm must also be ready to continually spend significant time and expense in maintaining the equipment,” Kennedy said.
- Depreciation. “Just like your car, the value drops the minute you leave the dealership,” Tirey said.
- Less available cash. If you spend too much of your available cash, you may not have enough in a time of need. “You won’t have that cash to invest in growth, like product development, marketing or hiring that new employee,” Tirey said.
Leasing pros and cons
One of the main advantages to leasing vs. buying is that you’ll keep more cash in your pocket, preserving your cash flow. “Lease payments are normally less than financing payments, so many prefer leasing to conserve cash,” Kennedy said.
Other advantages include:
- Staying current and competitive. “We see labs, high-tech firms, even fitness centers gain significant competitive advantage from having the latest and greatest equipment,” Tirey said. “These businesses prefer to have a three-year lease that allows them to turn in the equipment at the end of the period, so they can always have the latest equipment on hand.”
- Reduced maintenance costs. According to the Small Business Administration, maintenance may be included in the lease.
- More favorable tax deductions. “The tax consequences of leasing are generally better than purchasing or financing, at least for the first three years,” Kennedy said.
- Flexibility for short-term needs. “Leasing may be cheaper for projects of limited duration, and the small business owner is not stuck with unneeded equipment later,” Kennedy said.
Cons of leasing include:
- Greater overall cost. “Leasing companies often structure the agreement so that the small business is really paying for 100 percent of the equipment cost, but will still not own the equipment when the lease is finished,” Kennedy said.
- Complicated fine print. According to Kennedy, small businesses don’t always realize the complexities of the agreements. “When it’s time to deal with the expiring lease, there may be severe penalties for missed deadlines or changes to the equipment,” he said.
- Unexpected tax consequences. Many small business owners assume if the agreement says “Lease Agreement,” it’s a lease agreement. But under certain circumstances, the IRS may decide your lease is actually an installment or delayed purchase agreement, especially if you have the option to purchase the equipment at the end of the lease. Kennedy said if the IRS deems the lease a financing agreement, it may demand you amend old tax returns.