October 8,2004 | Oakridge Financial Group

In order to become a trusted advisor to your customers, you need to not only be knowledgeable about the products you represent, but you are going to need to understand financing options. Every customer is going to finance their purchase, they will either: (1) Pay cash, (2) Bank loan, or (3) Lease it.

Why do you need to be comfortable with leasing? Because not only do 80% of companies lease some of the equipment they use, and in 2004 it is predicted the U.S. healthcare finance market volume will top $300 billion.

Let’s go over your customers available purchasing options:

1. Cash – this is actually the worst deal for them. Why? They are paying with after-tax dollars! (i.e. if they are at a 35% tax bracket, they would need to earn $13,500 to keep $10,000)
2. Bank Loan – is that interest rate “effective”, “stream”, “annual”, “add-on”, or “yield”? Banks know how to make money, not only are bank loans usually “demand” loans which can be recalled at any time, they usually want a down payment and you own it at the end of the term.
3. Lease-financing – Leasing is the most flexible form of financing. The nice thing about lease quotes is they are in the form of a factor (i.e. 0.0234) – so it is the easiest for you to calculate the monthly payment. You customer will have the choice of ownership at the end of the term, which is beneficial for equipment that becomes obsolete within 3 to 5 years.

As a manufacturer’s representative, you need to control the entire sale. Options 1 and 3 are the only ones that give you that control. When your customer goes to a bank, you are losing control of part of the sale, arguably the most important part – the closing.

Calculating Payments
It is actually very easy. Your leasing partner will give you a “factor” chart which you can easily calculate the monthly payment based on any purchase price, term, and purchase option (see example):

These factors are for illustration purposes only. *FMV – Fair Market Value.

How do you calculate the monthly payment? Take the total equipment cost and multiply it against the corresponding factor. i.e. $25,000 x .02134 = $533.50/m for 60 months. If they want to buy it at the end, they usually would pay anywhere between 10%-15% in a FMV purchase option.

Remember these payments are “pre-tax” so in reality the actual cost can be much lower (depending on their tax bracket). There is one caveat – NEVER EVER give tax advice! Leave that for the doctor’s accountant, every practice is different, let their accountant decide on the final structure of the lease. You only need to mention there can be tax advantages in leasing.

FYI – Why factors? First of all, it makes your monthly payment precise and consistent for the term of the lease. Secondly, one of the requirements the IRS uses to determine if a lease can be treated as a “tax” lease is that “no interest rate can be disclosed.”

FMV, 10% or $1 Purchase Option?
To a large extent, this will be determined by the doctor’s tax advisor. Why? Because if the doctor has a large tax bill, they may want to use the equipment depreciations incentives (i.e. Section 179 and the first year “bonus” depreciation). Another consideration is what does the customer want to do with the equipment at the end of the term? Will they want to own it, give it back, or are they not sure. There are three popular structures and they all have an impact on the final cost to your customer.

1. $1 Purchase Option – is the best option if your customer wants to own the equipment and take advantage of its depreciation expense. In this case the lease is basically a loan, and they will have to write off the interest and depreciate the equipment. Fyi - In order for a lease to qualify as a tax lease, it must meet several IRS guidelines, one includes it not having a “bargain purchase option.” This always eliminates the $1 purchase option
2. 10% - this is a good option if your customer is not sure if they want the equipment at the end. At the end of the term, they will have the option to purchase the equipment at 10% of the original price.
3. Fair Market Value (FMV) – this is the only real option if your customer wants the lease to be treated as a “tax” lease. Generally speaking, the FMV gives your customer the lowest monthly payments, and if your customer wanted to buy the equipment at the end, they can pay the 5%-15% purchase option with future dollars. (i.e. if the term is for 5 years, they will pay the purchase option in 5 year old dollars, which is better than paying it in today’s dollars).

For more information on leasing:
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Jeff Russell writes about marketing and capital financing issues. He is the president of the Oakridge Financial Group, which provides capital to growing companies in the form of Equipment Leasing, Venture Capital, and Asset Based Lending. www.oakridgefinancialgroup.com