Buying and Leasing Equipment: Best Practices for Breweries
Within the last year, one of the most consistent questions we get is regarding whether a brewery should buy or lease equipment. We have particularly received this question most often with regards to the purchase of a canning line. So, in the next few paragraphs I want to go over how to think about whether buying or leasing equipment is the right move for your brewery.
First let’s discuss what it means to lease equipment. This lease arrangement is different than some of the leases with which you are probably familiar. Take, for example, the lease for the space your brewery occupies. This is called an operating lease. An operating lease allows you to use the space or equipment for the period of time as stipulated on the lease. At the end of the lease, if you no longer want to use the space you would surrender it to the landlord. The lease type associated with brewery equipment is a called a capital lease. In this lease you enter into a lease agreement for a period of time. At the end of the lease, you may have used up most of the equipment’s usefulness and will be given a bargain price option (usually, but not always, $1) to purchase the equipment. In a lot of ways the capital lease looks and works just like a loan. Therefore, when making the buy versus lease decision for a piece of brewery equipment, you need to look at the lease like a loan. Let’s look at the three best practices to consider when you are making this decision.
Terms Of The Lease
Look at the terms of the lease. There are a couple of things to look for in the lease documents to determine if leasing makes sense. First is the implicit interest rate. Because a capital lease works a lot like a loan, there is the consideration of interest and principal. A capital lease may not spell that out in the loan documents, but we can calculate out what the implied interest rate is. We can then compare that to the loan rates or the opportunity cost rate from the buy option to see what is the best scenario. The other thing we need to look at is what happens to the equipment if the it goes bad, malfunctions etc. Are the ownership rights transferred to the lessee (and therefore also the cost to replace/fix/etc.) or does the lessor still have rights and has to make the lessee whole?
Accounting Implications? No Worries.
Don’t worry about the accounting and tax implications. A capital lease works the same way as getting a loan and buying equipment, from an accounting and tax perspective. In both scenarios we have assets for the equipment, liabilities for the loan/lease, and recognition of expense through depreciation. The nuts and bolts accounting is a little bit more complex for a lease, but at the end of the day we get to the same place with both scenarios.
Ease of Transaction
Review the ease of the transaction. Generally, by leasing, the transaction will happen much quicker than going through the loan process with a bank. The leasing company has structured the deal where the lease is part of purchasing the equipment. Because the lease is very specific to the asset being purchased, it is generally easier to get the lease finalized more quickly than waiting for a bank loan to be underwritten and closed.
What are you purchasing?
If your equipment purchase consists of multiple pieces of equipment, leasing each piece of equipment individually may result in more costs and administrative work versus obtaining one loan and purchasing multiple pieces of equipment.
After looking through these considerations, breweries will generally choose to lease over buying equipment, particularly when purchasing one piece of equipment. Because capital leases are much more common in the brewing industry, the implicit interest rates are generally either matching what a bank is providing or beating it. Leases are generally easier to close, which also makes it an attractive option as well. However, we have seen cases where the capital lease was not read through carefully and costly landmines were later discovered. Had the brewery realized this ahead of time, they probably would have opted to purchase the equipment outright at the beginning. If you are unsure if a lease has any potential landmines, send it our way or have your lawyer look it over. The ability to easily obtain key pieces of equipment for your brewery is critical as you look to grow and scale. Therefore, it is important to make the right decision on whether you buy or lease the equipment.