Equipment Leasing Agreements

June 1, 2010

Are you taking a close look at the fine print before signing your equipment leasing paperwork? You should be. We show you why and what pitfalls to avoid.

Adding that expensive piece of diagnostic equipment or technology wouldn’t really be feasible without the ability to lease. That is, unless you’ve got a spare $30,000 to $4 million sitting around. Thanks to the joys of leasing, practices can obtain equipment without hefty capital, and upgrade it in a few years, if necessary.

But there’s a less savory side to leasing lurking in the lines of the leasing agreement. Without closely reading the fine print and understanding the terms - before signing - you could open yourself up to some costly headaches.

“You just need to be aware of what you are signing,” says Erik Jensen, senior vice president of Healthcare for Key Equipment Finance.

What happens if you don’t comb through the documents? You could find yourself paying for years on an obsolete piece of equipment, facing escalating monthly payments, or having actually purchased something you had intended to give back after the lease was up. Nestled in the legalese of your agreement are the terms concerning the length of the deal, the fees, your responsibilities, and more, and it’s a smart business move to know exactly what you’re agreeing to.

Bank vs. leasing company

One of the first decisions you must make is whether you want to lease the equipment from a leasing company or your bank. Of course, depending on who you ask, there are benefits to each option.

A leasing company comes with added convenience, notes Jensen. Often your practice administrator can set up the lease using some basic information from the physician and a signature, he says. A practice won’t necessarily have to have a large down payment, which can be the case with a bank loan, and vendors will align with leasing companies to offer “one-stop shopping” for practices to select equipment and set up financing, he says.

“The reality is, if a doctor has a phenomenal relationship with their local bank, a bank can probably beat a leasing company on pure rate, but we aren’t talking about a substantial rate decrease,” Jensen says. “And the trade-off is the convenience factor and the money down.”

However, some leasing companies don’t always have the practice’s best interest in mind. Some have been known to prey on physicians, charging exorbitant rates or setting up, say, a seven-year lease for equipment with a lifecycle of only four years, says Brian Bastis, a partner at Frederick, Md.-based accounting firm Ryan and Westmore PC. Most practices can get a line of credit for 3 percent or 4 percent from the bank, he adds.

Whichever option you select, it’s a good idea to know the lender and, of course, scrutinize the agreement. Similarly, you should feel equally comfortable with the vendor you’ve selected. Once that lease agreement is signed, you’re locked in, regardless of how the chosen equipment and vendor meet your needs, so be sure to do your due diligence on lender, product, and vendor.

“You want to know who you are doing business with,” Jensen says, “If you don’t read the fine print, there are bound to be surprises.”

Proceed with caution

Here are a few tips for navigating the leasing agreement maze:

Know the purchase options. Are you clear on what happens at the end of the lease? That’s going to be detailed in the purchase option. The most common capital lease (which basically means you are financing it to own) is the bargain purchase option, known as a “buck-out lease.” This allows you to purchase the equipment at the end of the lease for $1. This is more like a loan, Jensen explains, and the title of the equipment is transferred to the physician at the end of the period. Not a bad deal if you want to own the equipment. Of course, if you plan on giving it back at the end of the lease, this option isn’t for you.

The other option is a fair market value lease (more of a true operating lease), where the physician can either return the equipment to the lesser, renew the lease and keep making payments, or exercise the purchase option and pay fair market value (whatever that might be) to buy the equipment.

With a fair market lease, the payments tend to be lower, Jensen says, because the leasing company knows they can release or sell it later.

It’s important to know which one you’re signing, not only because of what happens at the end of the lease, but also because of the taxes. In the eyes of the IRS, if you have a buck-out lease, the practice can’t write the lease payments off as a business expense, and instead must depreciate the asset on their books and write off the interest, Jensen says. With the fair market lease, the IRS views the leasing company as the owner, so you can write off the payments as an expense.

Know your responsibility. Believe it or not, you’re on the hook for more than just paying your monthly statement. Jensen says there are three key responsibilities for the lessee:

  • Taxes. The taxation differs based on the practice’s location, as it’s a state and local issue, but it’s still up to you to pay the taxes on the equipment.

 

 

  • Insurance. The equipment must be insured, and you must show proof of that insurance to the leasing agent. If you don’t prove it’s insured, the leasing company may purchase the insurance on your behalf. And not every leasing company will charge you market rate for this insurance. Plus, you likely already have insurance that covers the equipment, so it’s just a matter of being diligent and proving it to avoid paying for it twice.

 

 

  • Maintenance. It’s also up to you to make sure that expensive equipment stays in working shape. Most vendors will sell you a service package, but the onus is on the lessee to maintain the equipment. Broken equipment becomes a problem if you have a fair market value lease and want to return it later. Plus, making payments on nonfunctioning equipment is bad for business.

Look out for these pitfalls. There are a couple of areas that can really get a physician into trouble with leasing agreements, says Bastis, who serves as treasurer of the National CPA Health Care Advisors Association.

 


The first is personal guarantees, which Bastis says he never recommends physicians sign. A personal guarantee basically says that if a practice can’t pay the lease payment then the physician will personally pay it.

“It’s in there quite frequently,” he says. And it’s a bad idea.

Second, watch out for increasing payment deals, where you agree to pay $99 a month for the first few years, and then the payments jump to $1,200 a month. This trend was more popular several years ago, and it continues to be a bad idea, Bastis says. You may find yourself with obsolete equipment paying staggering monthly bills, or even several leases with exploding monthly payments. Don’t be tempted here, and instead, look long term, he says.

It’s also a good idea to know the interest rate, Bastis says. The monthly rate might sound reasonable, but what happens when you learn it’s based on a 16 percent interest rate? Not such a good deal after all, is it? If that’s the case, perhaps you can try for a lower-rate loan with your bank, he says.

For his part, Jensen is more a fan of knowing the monthly payment instead of the interest rate. “You know in dollars and cents what’s required upfront and what you pay every month,” he says.

Get an expert to review the document. Even the savviest practice administrator would be smart to have an accountant or attorney review the lease. From the taxes, terms, penalties, and responsibilities, there are areas where complex language and confusing terms can trip you up, says Kenneth Hertz, a principal with the MGMA Health Care Consulting Group.

“If I am going to spend $50,000 or $100,000 or more for [equipment for] the practice, I figure buying an attorney’s time for $350 or $700 or even $1,000 is probably worth the protection,” says Hertz.

“If we are talking about a major expenditure, prudent business says really understand, explore, evaluate, analyze, ask lots of hard questions,” he says, “It’s the right thing to do.”

Sara Michael is senior editor at Physicians Practice. She can be reached via sara.michael@cmpmedica.com. Physicians Practice.

This article originally appeared in the June 2010 issue of