Should you lease vs buy equipment for your small business

When it comes to getting office equipment, tech equipment, or even heavy equipment you need to run your business, small business owners often ask: Is it better to lease or buy equipment?

There are pros and cons to each option. You need to determine what matters to you: having steady cash flow and a lower monthly payment? Having an asset on your balance sheet that you can sell down the road? Being able to turn in equipment and buy the latest technology? Paying the lowest price possible for equipment?

We’ll cover both leasing and buying equipment in this article to help you make the right decision about whether to lease vs buy equipment for your business.

How does equipment leasing work?

Leasing business equipment consists of making monthly payments to rent some type of equipment without owning it. At the end of the term, the lessor must relinquish ownership of the equipment. There may be the option to purchase it at a reduced price at the end of the lease.

There are different types of leases, including the capital lease, sale leaseback, TRAC lease, and others.

Key differences between leasing vs. Buying business equipment

The primary difference between buying and leasing equipment is that with the former, you own the asset until you sell or dispose of it. With leasing, you have access to the equipment for the life of the lease, and then you give it back to the company you leased it from—unless they offer you the option of purchasing the equipment at the end of the lease and you decide to take them up on that offer. 

Another key difference is cost: while buying equipment has higher upfront costs, it is usually cheaper in a dollar-to-dollar comparison with leasing. However, you also need to take into account the opportunity cost of using cash to buy equipment rather than spending it in other ways in your business.

Many businesses prefer to lease equipment because it helps them conserve cash flow (typically lease payments are lower than purchase payments), though there are benefits to ownership as well.

What are the advantages of leasing equipment over purchasing it?

So why consider leasing? There are many benefits of leasing over purchasing equipment.

Conserve working capital

The fact that equipment leases typically have a lower monthly payment than a loan for purchasing equipment is appealing to many businesses because it enables them to have a more steady cash flow to put toward short- and long-term goals.

Access better equipment

Speaking of those lower monthly payments: lower payments on equipment also means you may be able to afford better equipment than you would if you purchased it outright. Maybe you could only afford to purchase used equipment, but with a lease, you get the new equipment with the latest technology at a lower price.

Spend less on equipment up front

Many bank loans and SBA loans require collateral or a down payment to minimize the risk the lender takes on, but with a lease, there is none. The equipment is considered the collateral, so if you stopped paying your lease, the lessor could take the asset back. You can often lease equipment without a down payment, or with a very small down payment.

Deduct rental payments on taxes

This is true of purchasing equipment as well, but with an equipment lease, you may be able to deduct your rental payments as long as you are using the equipment in your business. The only caveat to this is if the IRS recharacterizes the lease as a sale, such as in the event that you decide to purchase the equipment at the end of the lease.

You don’t own an outdated asset

Equipment like heavy machinery or computers depreciate quickly, and if you purchase them new, you’re left owning outdated equipment that is worth a fraction of what you paid for it just a few years later. With a lease, on the other hand, you relinquish ownership at the end of the lease and can turn around and lease the latest version of the equipment.

What are the disadvantages of leasing equipment?

When it comes to an equipment lease vs. loan, there are some cons of leasing that may deter you from choosing this option.

There may be a higher overall cost

Despite the fact that your monthly payments may be lower with a lease than an equipment loan, in the long run, you will likely pay more for a lease, and you don’t have an asset to show for the expense.

You can’t cut out early

If, partway through the lease, you decide you don’t want or need the equipment any longer, you typically won’t be able to get out of the lease agreement. While lease terms vary, you usually will have to continue making payments or pay a lump sum for the rest you owe.

You don’t own the equipment

When you purchase, say, an industrial mixer, you can sell it down the road, even if it is for less than you paid for it. Some equipment holds its value better than others. But with leasing, you don’t have the financial benefit of owning an asset

Buying business equipment

Now let’s look at the flip side of leasing: buying equipment outright. Purchasing business equipment may require an upfront cash outlay, and then you have loan terms that require monthly payments. At the end of this term, you own the equipment and can do what you like with it.

Now let’s look at the advantages and disadvantages of buying business equipment.

Advantages of buying business equipment

There’s a lot to love about the ownership of equipment, even if you take out a loan to pay for it.

It’s yours

Once you finish paying off your equipment financing, the asset is yours to do what you please with. You could sell it and recoup a little of the investment you made, then turn around and buy newer equipment. Or you could hang onto it as long as it’s in good working condition.

There are tax deductions

Purchasing equipment outright has some tax benefits that you may enjoy. You can deduct up to the full purchase price of the equipment in the year you bought qualifying equipment, which will reduce your taxable income. This is called bonus depreciation and is in contrast to writing off the asset over its useful life.

Equipment financing lets you afford the equipment

An equipment loan may be an alternative to equipment leasing. Similar to leasing, a small business loan may ensure that you get the equipment you need without typing up cash.

If you don’t qualify for a low-interest equipment loan, you may find other alternatives like cash flow loans, merchant cash advance loans, or invoice financing to cover the expense. If it’s a lower-cost piece of equipment, even business credit cards are an option to consider.

Disadvantages of buying business equipment

Wherever there are pros, there are also cons. Here’s what to be aware of when considering buying equipment.

It may cost you more up front

If you buy equipment outright, or get a loan that requires a more substantial down payment, your cash flow can suffer. 

You’re responsible for maintenance costs

In addition to the initial cost of equipment, there are also maintenance costs through the life of the equipment you are buying, so factor these into the total cost of buying equipment.

You May incur long-term debt

If you do take out financing for your equipment, you will have loan payments for several years, which may impact your ability to take out other financing to grow your business or affect your business credit scores.

You’ll have depreciated equipment

By the time you finish paying off your loan for the equipment you purchased, it may be outdated, and its value will be far from what you paid for it. Leasing companies take equipment obsolescence into consideration when setting the terms of the lease; you need to understand it as well.

What typically goes into business equipment leasing that most SMBs miss?

Lease agreements can be intimidating. They are written in legal language that can be confusing. As a result, you may overlook important terms of the lease. Business owners may:

• Think equipment will have higher resale value at the end of a lease than it actually will. 
• Guess on tax breaks, without understanding what tax benefits they will actually receive.
• Comparing costs without taking into account the opportunity cost of funds used to purchase equipment outright.
• Not fully appreciate that a lease is a long-term financial commitment.
• Fail to carefully review and understand all the terms and conditions of the lease. 
• Not realize that business equipment lease payments may appear on their business credit reports. 

You can help avoid these pitfalls by reading the terms of the lease carefully, asking lots of questions, and getting help from your accountant or legal advisors to make sure you’re making the best decision for your business.

How to do a lease vs buy analysis

You can use a discounted cash flow analysis to compare the cost of leasing versus buying. This requires you to know key elements of the lease, including equipment cost, life of the equipment, lease terms, loan terms (down payment, interest rate, payment details), as well as taxes and tax benefits. 

SCORE, the non-profit business mentor organization, offers detailed examples of how to run a lease vs buy analysis in a detailed publication you’ll find here. It can be complicated, so you may want to ask your accounting professional to help you with this comparison if you’re not comfortable figuring it out on your own. 

What is the difference between lease vs rent?

An operating lease is similar to renting, but renting equipment is usually done on a very short-term basis (days or weeks) versus terms of 1-5 years or more. Renting equipment won’t give you the option of buying it later, as some leases do.

Is it better for a business to buy or lease equipment?

Now that we’ve reviewed the pros and cons of leasing versus buying, it’s up to you to determine whether buying vs. leasing is the best option for your business needs.

When making the decision, ask yourself:

• How much can we afford to pay each month for equipment?
• Is it important that we have ownership of the asset?
• Do we have cash to put down up front?
• How long will we use this equipment?
• How much does leasing cost versus buying?
• What will the realistic value of the equipment be after the lease ends?

If you’re not sure how to answer these questions, ask your CPA or accountant to help you analyze your options. If this is a major business purchase, getting outside advice can be worth it. (And the consultation fee is likely a deductible business expense!)

Nav’s final word: Lease vs. Buy equipment

Leasing has some great financial benefits, such as lower payments and not being saddled with an outdated piece of equipment. But buying, on the other hand, may be more affordable in the long run, and you have an asset you can then sell.

Carefully consider each option as well as your business goals, and then research business financing options that specialize in equipment financing or leasing.