Don’t buy anything! Why you should lease your IT

A person at a desk strewn with papers signing a document next to an open laptop

As great business ideas go, leasing is hard to beat. Rather than spending huge sums buying all your computing gear upfront, you can pay only for what you need, just as with your cloud resources, and take the cost out of each month’s operational expenses, not your capital budget.

Indeed, it’s an idea that’s far from unique to the IT department: it works in any business that makes use of big lumps of equipment. For example, it’s quite unlikely that you have ever flown inside an unleased aeroplane.

Leasing does raise some questions, though, especially as the leased items themselves continue to evolve. For many decades it’s been perfectly normal to lease a coffee machine, but nowadays you’re leasing the software it runs as well as the machinery that handles the actual heating and dispensing. Traditionally intangible, non-capital items are creeping into sectors previously reserved for the purely physical. Should these be a separate type of lease from the stuff you stub your toe on? If so, why is the payment process so different?

The Z-score problem

To an MBA, a lease is just a way of converting illiquid assets into movable, usable cash. As a lessee, you’ll be appraised somehow before the lease is approved and, once the contract is signed, it will naturally impact on your overall ability to support other loans.

But you don’t have to think of a lease as a liability. Smart, streetwise entrepreneurs realise that leases can increase your ability to make money by more than they deplete your ability to get funded by a bank. You exchange reduced access to capital for an increased influx of operating cash: in banking jargon, you improve your overall liquidity by converting dry assets into fungible monies.

Getting approved for the leases you need brings us to the thorny and subjective matter of the Z-score. For sober statisticians, this is a mathematical measure of volatility. To financiers, it’s slang for flaky customers. I’ve heard it said that one practical way of measuring a client’s Z-score is to visit the premises a week after a loan is approved and count the Porsches in the car park. In these times, the Z-score is a constant worry – there’s a lot of pressure on banks not to wreck the economy with too much lending – and you might struggle to get a loan to buy IT gear.

This is another benefit of leasing. The lender is quite often the maker of the kit or supplier of the service, rather than a bank, and they’re likely to have a much clearer view of your industry, your company’s profit-making potential and your likelihood of default. A close, bilateral relationship between your equipment supplier can be a great way of effectively sidestepping a potentially problematic Z-score.

Ownership and insurance

Lots of lease documents emphasise that the ownership of the item remains with the lender. You might end up taking absolute ownership at the end of the period, but this generally involves handing over a chunky sum, representing the depreciated value of the device in the lease company’s books.

This means that, in the meantime, you’re holding an asset that doesn’t belong to you – and, understandably, the lease owner needs to know that they will get their money back if your office burns down. The obvious answer is an insurance policy, but the situation isn’t as clear-cut as you might hope as some of the risk pertains to physical possession of the device, some to potential repair, some to its ongoing value and some more yet, indirectly, to factors under your control, such as your power supply, fire alarm and so forth. If you see a lease agreement that doesn’t include a good few pages on the topic of insurance, dig deeper and figure out exactly what might be expected of you. It is astounding just how many people are so swept away in the negotiation process that they end up signing a bad contract.

The franchise warning

In some parts of the business world, a lease can involve a lot more than a few legal niceties. The franchising model might not apply to many readers, but it’s an instructive example. Most people assume that a franchise will include a territory, a set of business processes, some equipment and maybe a bit of training – and most do. However, many also have required levels of revenue to go with the required frequency of customer contact, handover of customer data and mandatory upgrade and replacement cycles. It’s a great deal for the franchisor, as the costs and risks are passed on to you.

While such all-encompassing agreements are rare in the IT sector, lopsided contracts are never going to go away. The most enduring instances of abusive lease contract wording are often found in the photocopier business – and, these days, photocopiers have ways of taking over your network almost completely. Shared printing, direct-address scanning, pooling, even document management, can all be swept up in a contract girded by rules about anniversary date renegotiation, high early-finish penalties and even exclusivity clauses that forbid you from using your own on-site staff to maintain and repair your leased hardware. Almost all old-school IT people will have stories about such iniquitous arrangements and, as usual, they’re worth listening to.

When leasing doesn’t make sense

For lease contracts to function correctly, they’re expected to produce a financial gain for the equipment’s owner, which isn’t you. As you’ve probably guessed, the easiest way to lock in this profit is to ensure they earn more money than the devices’ original purchase price over the timeframe that it is put out to lease.

What happens if the market you’re operating in changes more rapidly than the lease lasts for? This isn’t necessarily a frequent problem in industries where you rent out planes or cement mixers, but in the world of information technology it’s more than likely to happen. Take iPads in the education sector, for example. Many schools tend to prefer leasing when it comes to providing their students with tablets, mainly because they don’t have huge capital budgets. This helps them to shift their costs to the desired area in their budget.

The downside is that many employees in charge of this area may view iPads as a constant entity, especially as if they tend to usually deal with telephones or photocopiers. Leasing contracts don’t tend to usually provide automatic intelligence about the obsolescence cycle of whatever you’ve rented.

Unfortunately, this means that many schools currently work with devices that are a few generations old, when it comes to their software or hardware compatibility. To make matters worse, some naive equipment renters have even hidden the old devices they’ve rented on a dark shelf while splurging their emergency budget on some up-to-date ones. The problem here is that this could make the situation even worse, as it relies on the marketplace of educational software keeping up with the upgrade cycle’s instability and progression.

Once again, the problem here is much bigger than purely focusing on the information technology at hand. You can see a similar technique employed by governments who want to fight wars when examining the huge quantities of debt washing around the banking system. These governments are still making the odd payment, over a hundred years later, for military equipment which can now be found rotting somewhere in the depths of the ocean.

There’s no clear and obvious choice you have to take here, but careful planning will always win. Your organisation might require short-term access to a range of equipment in a way that no organisation that provides leases would be able to translate into a profit, especially if you’re a systems developer or tester. This is more of a warning to not assume that renting out your equipment is always good, despite its benefits. You can always expect to find a traceable rationale that will help you form a conclusion as to whether you’re in a situation which will benefit you to lease or not.

Before you select your decision, you should consider at least one more thing. Occasionally, some leases will be provided with attendant costs as well as your regular payments. If you’re not careful, this could leave you in quite a bit of shock if you aren’t aware of the costs this can incur. For example, a number of companies were left with their eyebrows raised after leaping to lease a fibre-to-the-premises internet connection, which came with several thousand pounds of costs for trench-digging. Since this expense was particular to their site, the companies weren’t able to recover or resell it at the end of the lease, meaning that the costs wouldn’t be able to be subsidised by the fibre provider. It’s extremely important to take this into account when making a calculation of this nature as it will ultimately prove whether a leased asset is worth the trouble or not.

What should always be leased?

It usually always makes sense to lease if the piece of equipment will probably be used again for a significant amount of time once you’re finished with it. As the lessor won’t have to acquire their whole investment back from you, it might be more economical for you to rent instead of purchasing, especially as it’s less wasteful too. This is a broadening category since new technologies with the ability for high component recovery become more and more widespread.

Here we’re very much talking about infrastructure as well as client devices, and things start to overlap with cloud services. It’s a long time since it made sense to own a web server, and once you’re leasing the hardware it’s only logical that it should be located in a data centre, and then perhaps it doesn’t need to be a physical server at all. Advantages such as containerised virtualisation, Docker, Kubernetes and the distinction between scale-up and scale-out mean that you are far better off using a virtualised, load-sensitive, infinitely expandable web farm than to keep pushing the hardware beyond its sensible limits.

If there’s one point to take away, it’s this. When you think of leasing, you might think of the 20th-century idea of leasing a TV set or a fridge-freezer – as a way of getting something you can’t really afford. That doesn’t sound like a smart way to run a business. But business banking is getting ever more risk-averse to big loans and cash overdrafts. At the same time, the rise of the cloud, remote working and other diffusing factors mean the days of a large, centralised IT inventory are gone.

As a result, leasing is not just a viable, sustainable way to meet your IT needs: it’s a powerful idea for both resellers and lessees, and a stronger financial play than a cryptocurrency or venture capital fund.

This article was first published on 23/11/2019, and has since been updated