FMV vs. EFA

(Fair Market Value Lease vs. Equipment Finance Agreement $1.00)

PEC USA, Inc. is often asked to provide Fair Market Value lease quotations for customers.  This request is usually from an applicant that perceives the FMV lease as a “walk away” lease, with no obligation at the end of the lease and a full tax benefit of expensing the monthly payment over the term of the lease.

PEC USA, Inc. has the capability of writing a “True Lease”, “Operating Lease”, or a “TRAC Lease (rolling stock)”.  The leases are set up to provide the depreciation of the equipment to the lessor in exchange for a lower rate.  The lessee would expense the monthly payment of the lease and carry the lease as a “lease” on the respective company’s financial statement “representing” a lower current portion of debt and overall lower liabilities.  This product really needs to be reviewed by a Certified Public Accountant, the company’s CFO and controller to make sure the respective company can fully utilize the tax benefit.

An FMV lease on a new printer, machine tool, computer system, telephone system or packaging machine is not a “tax tool” or “cash flow tool” – it is in fact a “vendor retention tool”.  An FMV lease forces the lessee to make a new purchase decision at the end of the lease.  This keeps new equipment churning into your business every three, four, or five years.  At the end of the FMV lease you can either, return the equipment to the leasing company, upgrade the equipment with your vendor and “blend” the residual of the old lease into the new equipment, or you can buy the equipment at the end of the lease.

I (Joe Friedling) personally worked at a large leasing company specializing in office equipment (copiers) and believe me – you do not want to return a piece of equipment to a leasing company unless you are an expert at it.  Be prepared to have all of the original operating and installation manuals, software, and even the original shipping cartons and return the machine packaged like it was new.  If you read your lease you will have to provide the leasing company a letter of intent to return the equipment at pre-determined time or you will go into renewals (you will have to continue to make payments on the equipment for thirty, sixty, or ninety days).  Then you will have to pay return freight on the equipment (usually they won’t quote freight until it has arrived at one of the return centers).

The hours spent “returning” the equipment and the bill for damage, missing parts, etc. will not be worth what you think you are saving – believe me, I’ve seen it dozens of times.
Of course you can “upgrade” your equipment with your equipment vendor but guess what?  The difference in what that equipment is worth compared to what the residual was priced at is now priced into your new equipment and you will pay for it over the next lease.  Again I’ve seen it hundreds of time.

What about purchasing the equipment at the end of the lease?  That’s fine but you may not get the “inside” buyout number and it would have been cheaper to do a $1.00 buyout in the first place anyway. 

Leasing companies do not make money with FMV leases on stream of payments waiting for a residual.  They make money on documentation fees, late charges, renewal payments, and “return charges” if they have to.

A perfect example of this is one of the major leasing companies offered a “zero percent” special about two years ago.  36 months at “zero percent” basically taking the purchase price of the equipment divided by 36.  But with the 18% residual that was priced in at the end of the lease, the first and last payment, and the $350.00 doc fee the interest rate was almost 13% – this was when mortgage rates were in the high 4% area.  A good $1.00 purchase option lease was probably around 8%.

Let’s compare a decent 36 month FMV lease to a decent 60 month $1.00 purchase option lease.  Let’s use a $25,000 piece of equipment.  The FMV will have a 15% residual.  I’ll explain why I want to compare a 36 month FMV to a 60 month $1.00 purchase option (with the obvious difference being 24 months).

1. The payment is much lower $705 FMV / $550 $1.00

2.  At PEC USA, Inc. – if you qualify you will put down zero – no advance payments and even if we have to bill you $100 doc fee it can be invoiced with your first payment – a true no money down deal.  An FMV will probably take first and last payment plus a doc fee – less cash flow, more out of pocket.

3. At the end of 36 months on the FMV you HAVE to make a decision.  You have made 36 payments and you have nothing.  Either purchase the equipment at the 15% ($3,750), return it with the hassles described above – or have your equipment vendor come in and upgrade.  At the end of 36 months with a 60 month $1.00 purchase option lease you have equity in the equipment, you have a lower payment (better cash flow), you have had better cash flow the whole time – and you DON’T HAVE to make a decision – you just keep working the equipment.  If you really need new equipment or need to upgrade PEC USA, Inc. will use the equity in your equipment to help you upgrade – there is no residual to overcome, and we will upgrade you with no prepayment penalty.

4. An FMV lease is also marketed as a tool against planned obsolescence.  There are some products out there that are useless after three years, but for the most part a decent piece of equipment in most industries can continue to produce revenue for more than five years.  Again, at the end of 36 months on an FMV lease a new piece of equipment will be coming in as a replacement.  If the old piece is removed there will be a gap that I call “technology transfer cost”.  If you interrupt revenue production by removing the older equipment and have a learning curve with the new equipment you will be experiencing “technology transfer cost”.  If the original piece of equipment is allocated with a $1.00 purchase option lease and another piece of equipment with higher technology and / or production capacity is implemented after 36 months alongside the original equipment there is no “technology transfer cost”.  Once the new equipment is up and running the older equipment can be sold, or more favorably be run and continue to produce revenue with an existing process or product.

This is a pretty involved comparison.  PEC USA, Inc. likes it when more equipment gets purchased and we don’t want to alienate any equipment vendors by “bashing” the FMV lease.  But unless your company has completely reviewed your equipment purchases with your accountant and your equipment operators with the knowledge in this comparison you are better off with a $1.00 purchase option lease.  It’s cheaper and more predictable – period.