A guide to leasing

According to Gartner's IT Leasing Basics Toolkit*, a lease is a contractual arrangement by which the owner of the asset (the lessor) grants the use of his or her property to another party (the lessee) under certain conditions and for a specified period of time.

"A lease is an unconditional, absolute agreement. The main parties in a leasing transaction are the lessee, who uses the equipment, and the lessor, who owns it. However, it is important to make a distinction here; not all leases are true leases. They are really just another form of a loan or financing. In most cases, these 'non-true' leases will be what is known as a 'full payout lease' whereby you are paying for 100% of the equipment cost, plus interest. Ownership will generally transfer to the lessee at the end of term."

According to Gartner, leasing is a tool for resolving financial, technological and organisational demands in the context of equipment acquisition.

"The advantages of leasing are many, but so are the dangers and pitfalls when it is not done well," the research company says.

"The full advantages of leasing are only gained through careful negotiation between lessees and lessors. These negotiations provide opportunities, and for the uninitiated, the potential for substantive, unpleasant surprises.

"For the lessee, much of the risk lies in matching the asset's useful life with the term in the lease. For the lessor, the predominant risk lies in the combination of the assumed residual value and the 'stick factor' - the projected propensity of a leased machine to remain in place after the expiration of the initial lease term. Studies have shown that 60% of all equipment leased is upgraded during the initial term, extended beyond the initial lease term or purchased at the end of the lease term."

Gartner believes leasing and financing sources are many and varied.

"Manufacturer-provided financing of products is an integral part of the marketing process. Product offerings can be combined with financing packages to improve overall sales results. Since much IT equipment other than PCs is leased, many suppliers have decided that they need a leasing programme to assist in sales situations.

"Since leasing is their primary business, independent leasing companies are often very aggressive in their approach to pricing and service offerings. Independent leasing companies are vendor-neutral and, as such, have no allegiance to any particular vendor. This negates supplier lock-in, although you may be locked into the lessor. As the manufacturer-affiliated lessors win more market share, many independents have exited the business of leasing IT equipment. Bank leasing companies are generally more conservative with the residual value positions they take on equipment, which has the potential to increase lease rates," the company notes.

"However, the lower borrowing rates available to banks may offset the more conservative residual value positions they take. Leasing works best when companies match the terms of their leases to the amount of time they expect to use the equipment," the company says.

"When companies do anything other than what was originally intended (such as returning the equipment to the leasing company at the end of the lease), additional costs are incurred. These costs will depend on what's done (that is, early termination, extension, renewal or end-of-term purchase), the relationship with the lessor, and the underlying terms and conditions."

Gartner recommends clients ask the following questions when considering a leasing agreement:

* What is the real replacement cycle? Does management accept the need to replace servers on a regular and pre-defined (lease term) basis or do they tend to use the equipment for indefinite periods of time?
* Is the enterprise planning to lease this equipment as part of a well thought-through strategy with strong consensus across the organisation?
* Does the enterprise have control of the means to keep track of the physical and contractual aspects of equipment during its life cycle and to plan for equipment replacements and facilitate returns at the end of the lease term?
* Is there an implementation plan for hardware upgrades and modifications to support expected new software and enhancements to software for the term of the prospective lease? In other words, is the equipment being leased powerful enough to run the applications expected to be deployed during the lease term?

If these questions cannot be answered positively, then leasing will not be an attractive alternative for the long term.

Gartner further recommends the following:

* Understand what the company motivations are for leasing IT equipment.
* Work with accountants and financial advisors to ensure the company gets the type of lease needed (operating or capital).
* Negotiate contract terms and conditions carefully.
* Negotiate the price of the hardware first, then talk about alternative funding models.

* Courtesy of Gartner Africa.