Technology: Should You Buy or Lease?

Be careful how you answer. Many medical practices make buying and leasing decisions in the dark, lacking information about either the product or the lease agreement, or sometimes both. Worse yet, they never ponder the differences between leasing and buying a piece of equipment. Do you know which option is best for your practice? Or will today’s seemingly thrifty decision end up costing you more tomorrow?

A critical question to ask

Most practices have a “buy small, lease big” mentality, meaning that they pay cash for less costly equipment while leasing bigger-ticket items, such as imaging equipment. Others buy everything, either with available cash or a hefty bank loan. Practices such as these are asking, “How much money do we have right now?”

But that’s not the right question.

“The main thing is the technology,” says Fran Lavallette of Healthcare Facilitators in Orlando, Fla. His company consults with medical practices about purchasing and leasing decisions on a regular basis. “When the practice is looking at the equipment, how long do they think it’s going to stay relevant?”

In other words, stop worrying about how much it costs, and ask yourself this: How long is this piece of equipment going to be useful?

The answer to this question will largely determine whether you should sign a lease or a purchase agreement.

To illustrate, consider your ultrasound or EKG machine. Yes, it will function for more than a decade. But will you still want to use the same machine in 10 years? Any piece of equipment that the industry is likely to update often - either its hardware or software - is a good candidate for leasing.

It’s true that you’ll pay less in the short run if you simply buy the equipment, admits Lavallette, but don’t think you’ll recoup any of the cost when you decide it’s time to dump it. Resale values for older medical equipment and software is negligible. “If you try to sell this stuff, it has no return value.”

That was one of the primary concerns for Boise Orthopedic Clinic when it purchased an MRI three years ago. “With MRIs, generally the equipment doesn’t become too outdated,” says Connie Kniefel, the practice’s administrator, “but the software that drives it has to be continually updated for the protocols.”

A lease with an option to update the equipment at the end of the term gave Boise Orthopedic the kind of flexibility a bank loan couldn’t.

Kniefel doesn’t believe in leasing only really big items. The practice also leases smaller equipment, such as photocopiers, with flexibility built into the agreement. At one point, the practice leased a number of copiers, which they placed in a variety of places to save staff the time it would otherwise take to walk to a dedicated copy room. As the practice migrated to an EMR and needed scanning equipment, the lease allowed them to swap the copiers for more sophisticated machines that could both scan and copy.

So be sure to keep in mind how your practice’s needs might change in the future. Some equipment - office furniture, exam tables, and the like - doesn’t need regular updating, so it’s safe to purchase it. But for moving targets such as technology-based equipment, leasing may be your best bet.

Make a business decision

If you ask most practices whether they performed a needs assessment before purchasing equipment, you’ll likely hear crickets chirping. Most practices only go as far as saying, “We need it.” You need to go a step beyond. “[Practices] need to do feasibility studies and really determine how much it’s going to take to afford the equipment, as far as how many patients they have to see and procedures they need to do,” advises Lavallette.

It’s a good idea to look at how many procedures in the last year were or would have been supported by the equipment you’re considering. Based on that number and the amount each procedure would net the practice, how long will it take to recover the cost of the equipment?

Boise Orthopedic did its homework before signing a lease on its MRI. “We did a business plan and had various scenarios for what happens if the payers or if the scenario changes for the favorability of payment for advanced imaging,” says Kniefel. “They figured out how many MRIs they were already outsourcing, so they had a good idea what the projected volumes would be.”

Practices should also base financial projections on their typical payer mix. A larger Medicare population, for example, means a lower collectible for procedures. Typically, says Lavallette, practices make decisions based on “the vendor told me I would make $900 on that procedure.” That might be your practice fee, but that’s not what you’ll collect from an insurance company. You need to figure net income into your calculations to understand the true revenue potential of any piece of equipment.

Get a lease on leases

Buying equipment with a bank loan is pretty much like the mortgage on a house or the loan for a car. You’ll go through an approval process to verify your practice’s assets, and then sign an agreement to pay principal plus interest (usually at a fixed rate) over a set period of time.

Leases work differently: Terms can be set between 36 and 60 months, and sometimes require one or two months of advanced payments. Although most leases carry a higher interest rate than a bank loan (12 to 15 percent on leases vs. 8 percent and less on bank loans), you’ll find that the more expensive the equipment, the more likely you can negotiate a competitive rate. Case in point: Boise Orthopedic leased its MRI through the equipment manufacturer, which gave the practice a lower interest rate than the local bank.

But here’s the big question with most leases: What happens when the lease expires?
Some come with a one-dollar purchase option, called “buck-outs” in leasing industry-speak. A buck-out clause means exactly what you’d suspect: When the lease terminates, the practice can buy the equipment for $1 - a good option for practices that want to buy less expensive equipment, avoid any hidden fees at the end of the lease, and make sure that the equipment is upgraded or maintained over the leasing term.

Larger equipment typically comes with a fair market value lease. At the end of this lease, the practice would be expected to pay whatever price the equipment could be sold for on the open market. The advantage of this kind of lease is that the payments are typically lower because the leasing vendor knows the equipment will retain some value. On the other hand, the leasing company usually assigns the fair market value; an unethical company could inflate the price. If possible, try to agree on the fair market value of the equipment and have the leasing company write it into the leasing contract.

Haggling 101

Larry Wintersteen, a practice management consultant in Star, Idaho, has been advising practices for more than 35 years. He is seeing more practices opt for leases because of the ability to upgrade equipment. But that doesn’t mean leasing is without risks. “You need to read the fine print,” warns Wintersteen.

Some good questions to ask your leasing vendor are:

• Is the lease transferable? This is an important consideration if you’re thinking of selling your practice anytime soon - or even if you’re just thinking of bringing on other partners to share in the practice’s liabilities and assets. “It’s amazing how many practices will sell, and then they find out that the lease isn’t transferable,” says Wintersteen. Sometimes the leasing company will let you write a new lease, but usually at higher terms. Other times they won’t let you transfer at all. What does a practice do then? “They don’t have any option,” says Wintersteen. “They’re kind of trapped.”

• Does the lease automatically renew? This is not as common as it used to be, but some leasing companies still insert “evergreen” clauses into contracts. Basically, this provision says you must notify the company of your intention to return equipment within a certain time period before the lease expires. “A lot of people wait until their lease is up,” says Wintersteen. “But the fine print says you have to contact them 90 days before.” Check for automatic renewal in your lease, and be on guard for cutoff dates so you don’t get trapped in a lease that automatically renews for another year or two.

• What are the costs at the end of the lease? If you decide to return leased equipment at the end of the contract, be sure you don’t end up owing a large amount of money. Many leasing companies include a provision that allows them to charge you for damage or unexpected depreciation on the equipment. It’s only fair that you be held liable for any damages you have caused, but are you sure the leasing company will be fair? Before you sign anything, make sure you understand the potential liability for damages or depreciation by getting specifics on terms such as “damage” or “unexpected” depreciation.

• Is there an indemnification clause? In our litigious society, it’s no surprise that a leasing company wants to protect itself against a lawsuit with an indemnification clause. It’s also no surprise that such clauses often protect leasing companies at the physician’s expense. These clauses usually hold your practice liable if a patient sues the company because of an injury incurred during the use of the leased equipment. This is akin to writing the leasing company a blank check. Ask them to remove it from the lease contract.

• Who pays taxes and insurance? Not only that, but who reaps the tax benefits? In some states you can claim depreciation from leased equipment; in others, you can’t. Check with your accountant on which side of the fence your state falls. Also, make sure an insurance premium isn’t included in your lease payments. Often, you can insure the equipment separately, through your practice’s existing insurance provider.

• Who is responsible for maintenance? Most leasing contracts specify that the vendor is responsible for equipment maintenance, but make sure you know what that maintenance really entails. Boise Orthopedic learned this lesson the hard way when the chiller on the MRI unit failed. The vendor was responsible for preventive maintenance on the MRI itself, but the practice needed a separate maintenance agreement with a local HVAC company for the chiller. The repair ended up costing them around $8,000.

• What is the real interest rate? Read over your final leasing agreement to determine the actual interest rate. “Typically, they are not really clear about it,” says Lavallette. “There are a lot of references, and usually the terminology looks a lot like a credit card agreement.” Use the final monthly payment - which includes administrative fees, insurance, sales tax, etc. - written into your leasing contract to figure out what the interest rate truly is. You can use an online mortgage calculator for help with this.

• What else can you get? When it comes to leasing, everything is negotiable. Boise Orthopedic managed to extend the warranty coverage of its MRI by an extra year - just by asking. Maintenance and warranty coverage are always easier to secure because there’s no automatic overhead coming out of the salesperson’s pocket. You might also be able to score a good price if you approach vendors or leasing companies near the end of the quarter or the end of the company’s fiscal year, when they’re desperate to make their sales goals. “A lot of people just accept the price and think that’s OK, but basically what you learn is that it is OK to ask for the outrageous,” says Lavallette. “Sometimes you get surprised.”

One last warning: Even if you do negotiate a fantastic deal from a vendor or leasing company, keep in mind that there is one fundamental difference between leasing and buying: Unlike a bank loan, you can’t pay off your lease early. Sometimes a company will let you break your lease with a substantial penalty, but usually you’re stuck with those monthly payments for the entire term of the lease. A lease is a commitment. Be sure you’re practice is ready to make it.

Robert Anthony, a former associate editor for Physicians Practice, has written for the healthcare and practice management industries for six years. His work has appeared in Physicians Practice, edge, Humana’s Your Practice, and Publisher’s Weekly. He is based in Baltimore, Md. He can be reached via editor@physicianspractice.com.

This article originally appeared in the September 2007 issue of Physicians Practice.