We are getting closer to that time of year when businesses are most active adding new IT hardware. Many finance these new acquisitions with lease financing.
In the 1980s, I was in the leasing industry and saw first-hand many sneaky tricks that are still in use today. If you are unaware of them you may wind up paying WAY more than you ever expected and, unfortunately for you, you will have no legal recourse to get your money back.
So, how do you protect yourself? Well, here’s what to look for:
Fair Market Value vs. Fixed Dollar Buyout,
Sneaky Trick #1 — Mutually Agreed Upon FMV at Lease- End
Sneaky Trick #2 — Auto Renew Clause (aka “Evergreen Clause”)
Sneaky Trick #3 — Long Advance Notice to Cancel
Sneaky Trick #4 — You Are LOCKED IN to Your Lessor as Your Supplier
Moral
Fore-warned is fore-armed. Your best defense against sneaky tricks is your own expertise. The next best thing is to work with a computer source (yes, like Source Data Products) that knows all the tricks and has a built-in incentive to protect you from them…because they depend on your loyalty over the long term — lease after lease. Beware of “strategic partners” that are more interested in quick bucks than in long-term business relationships. You might be thinking “partnership” but they are pursuing their own strategy. Guess who is going to “get the business.”
P.S. This is the first in a series. The next part will cover Software Fair Market Value: Set-Up for a Nasty Surprise; and Interim Rent: Extra Fees that Would Make a Pickpocket Envious.
Fair Market Value vs. Fixed Dollar Buyout
Leases fall into two general categories: fair market value (FMV) or fixed dollar buyout.
An FMV lease does not pay off the full purchase price of the product over the term of the lease. You will not own the asset. Instead, you are renting the product from the owner, the lessor. At the end of the lease you can return the product to the owner (lessor), renew the lease for another term at the same or lower price, or buy the product at “fair market value.” This type of lease is very common for cars and computers.
A fixed dollar buyout lease is more like a loan without a down payment. You finance the product over a term with a pre-negotiated buyout option, say $1. At the end of the lease, you pay the $1 and you own the product.
From an accounting standpoint, each lease is treated differently. For the sake of simplicity, an FMV is booked on the financial statement like a short-term rental. One advantage is that the lease does not appear as a long-term liability, which may be beneficial for a company that borrows money (The FMV lease looks like there is less borrowed money because there is no long-term liability, as in a regular loan).
The second advantage is that the term of the lease may match the useful (productive) life of the product. Said differently, let’s say you only need a car for a 2-month project. It may not make sense to finance it over five years to own.
Sneaky Trick #1 — Mutually Agreed Upon Fair Market Value (FMV)
On the other hand, with a FMV lease that you probably want to own it at the end. How do you determine what is “fair market value”? This is a REALLY important point to have a clear understanding of — in writing — before you jump in…because both parties — you (the lessee) and the owner (the lessor) — have to mutually agree what that price is or how it will be determined.
FMV is not so simple. It is actually a way for the lessor to extract a lot more money out of you at the end of the lease — and you have no idea what you are in for. For example, one notorious Santa Ana, CA-based leasing company stated in their FMV lease that fair market value was to be mutually agreed upon by the lessee and the lessor at the end of the lease. Sounds innocent enough, right? Wrong!
It also mentioned that if the lessee (you) and the lessor (owner) could NOT agree, then the lease would automatically renew for one year at the current monthly rate. (Sometimes a longer term is specified.) So what happens? You find three computers similar to yours that originally cost $100,000, and five years later, they sell (used) in a range from $8,000 to $12,000. You suggest to the leasing company that $10,000 seems like a fair price. The leasing company disagrees and states that it believes the fair market value is $50,000. Clearly, there is no mutual agreement. And while you haggle over FMV, the lease auto-renews at an onerous price for a term you did not expect.
Sneaky Trick #2 – Auto Renew Clause (aka “Evergreen Clause”)
A lease may have an auto-renew — or evergreen — clause stating that when you fail to notify the leasing company of your intent to cancel or return the computer, the lease automatically renews for a new term of one year — or more.
So, as the months go by without an agreement on the fair market value, the lease automatically renews for one more year. You just got burned.
Sneaky Trick #3 — Long Advance Notice to Cancel
Wait a second! Can’t you just give the computer back to the leasing company if you can’t agree? Well, some leasing companies include a clause that you must notify them by certified letter to a specific address 6–12 months in advance of your intent to cancel the renewal and return the computer.
This may sound reasonable when you first jump into the lease. However, very few lessees know 6–12 months in advance what their specific plans are for that computer. So if, sometime after the 6-month period of notification, you attempted to mutually establish the fair market value but had no luck — gotcha! The auto-renew clause just went into effect for one more year.
Clearly, the leasing company expects that no one will remember when or how to notify them of termination. Incidentally, this trick is not limited to leasing companies.
Sneaky Trick #4 – You Are LOCKED IN to Your Lessor as Your Supplier
Suppose you are two years into your computer lease and you need to upgrade for more performance. Good news! Prices have dropped and you can get the needed upgrade even cheaper from the open market. Not so fast! Your lease may include a clause that, because the leasing company owns your hardware, it has the first right to refuse any upgrade you might want to add. Sounds reasonable at the time of signing because the leasing company will have to re-market the computer at end-of-lease and it doesn’t want any “weird” upgrade that makes the computer too hard to sell. But in fact, this clause really means you have to buy your upgrade from the leasing company, at their price. Their monthly payment increment may mask a price higher than you would pay on the open market. Gotcha again!
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