Many businesses opt to lease assets, rather than purchase them. However, there are several potential downsides to this asset leasing strategy.
It can be expensive
When you consider the total repayments you might make over the full term, it can add up to a significant amount. The total you repay could well be more than the market value of the asset itself – all for something that you never end up owning.
Non-payment can be costly
If you fail to make the required lease payments, the lessor can seize the asset and prevent you from using it. The missed payments are also likely to appear on your credit report and thus affect your ability to obtain financing in the future.
You might have to be VAT-registered
Some smaller firms don’t register for VAT because their turnover is so small, but this might affect your ability to obtain approval for a leasing agreement.
The asset could become obsolete
Some forms of lease agreements might have terms of 10 years or more. By the time this term ends, the asset could already have reached the end of its useful life, or it might have become obsolete, effectively superseded by more advanced technology. Therefore, you could find yourself continuing to make payments on something which is no longer of practical use.
Can’t benefit from increases in the asset’s value
Depending on what the asset is, its value might be expected to increase over time. If this proves to be the case, you won’t benefit from any such increases as you aren’t the owner of the asset.
Loss of the control that comes with ownership
You aren’t the owner of the asset under a lease agreement, so it’s unlikely you will be able to make any significant modifications to the asset, at least not without the owner’s permission.
You may have to maintain the asset
Although you don’t own the asset, you might still have to meet any associated maintenance costs during the term of the agreement.
The agreement may be restrictive
Sometimes the lessor will place restrictions on how the asset can be used.
It could affect the valuation of your business
In one sense, an asset lease isn’t debt, in that it doesn’t appear as a liability on your balance sheet. However, any investor is still likely to regard it as a debt and will adjust their valuation of your business accordingly.
It could affect your ability to obtain other financial options
Another occasion on which your asset lease is likely to be treated as debt is when you apply for any other form of financing. Entering into a lease agreement could therefore make it less likely that your future finance applications will be successful.
Paperwork can be complex
Many firms that have entered into lease agreements have found the administration involved to be unwieldy.
There could be early termination penalties
The lessor may require payment of a fee if you want to terminate a lease agreement early. Some firms, therefore, report that a lease agreement can be very difficult to get out of once you have entered into one.
When might asset leasing be suitable?
Asset leasing is most likely to be suitable for businesses that don’t want to be burdened with the responsibilities of owning the asset. Perhaps you are worried about depreciation or don’t know exactly how long you will want to use the asset.
Potential advantages of asset leasing include:
- Although some assets might increase in value over time, others depreciate in value. If you don’t own the asset, then you don’t need to worry about potential falls in its value
- One form of asset leasing is known as a finance lease (or a capital lease) and these can be very flexible. At the end of the primary rental period, the business may be able to do any of the following: negotiate the rental of the asset for an additional period, simply return the asset to the provider, or sell the asset
- It might allow you access to a higher quality asset than might be the case if you were looking at purchasing an item
- Lease payments will be fixed throughout the term, so it’s easy to budget
- Lease payments are usually tax-deductible
