Buy or rent? How can SMEs avoid some hidden pitfalls?

The words: “If it appreciates, buy it, if it depreciates, lease it” are generally attributed to John Paul Getty, the oil billionaire who died in 1975.

While on the face of it the maxim makes eminent sense, the economic world in which 21st Century SMEs live is infinitely more uncertain and complex, thanks to such influences as globalisation, the 2008 financial crash and, more recently, UK’s decision to leave the EU.

buy or rent contractsNot only that, most service suppliers want to lock in clients for long-term contracts similar to traditional property rental agreements.

Furthermore, long-term agreements, like financial contracts have become increasingly complex.

Modern businesses that provide lease or rental agreements often have terms and conditions that mean the lessee cannot just hand back whatever it has leased, not to mention the payment of financial penalties if they wish to terminate a lease early. These contracts mean that a business is left with a liability rather than an asset to realise.

If an asset is depreciating, it does beg the question as to whether a lessee shouldn’t wait for it to devalue to a point that justifies buying it second-hand. However, whether you are leasing or renting you will always be funding the depreciation, as well as profit for the vendor and lender.

Where a business is considering investing in new plant or equipment to facilitate growth the cashflow argument is that leasing allows it to upgrade or improve without making a substantial, upfront investment. This may not benefit profits when compared with alternative ways of funding the asset.

It can also make sense where a business depends on equipment such as office computers that can become obsolete in a relatively short time.

However, my perspective on this is that there is an assumption that everyone makes that there is, or can be, continuous growth and that therefore it is worth waiting to return an asset.  But if circumstances change you end up with the liability of having to continue paying when you no longer need it. An example of this is most cars are now sold under a PCP deal. Personal Purchase Contracts are not purchases but leases with horrendous terms that are applied to make the monthly payment look reasonable, however the cars cannot be returned early without incurring a huge penalty.

We would argue that the better strategy is to own or lease assets on short term agreements. Owned assets can be bought using hire purchase finance providing the asset can be sold with the funds clearing the HP settlement value. Shopping around for HP deals is likely to find a better one than that offered by the vendor. Short term agreements are more tricky and the small print needs checking but essentially you are looking to avoid being locked in to a long-term contract or one that is expensive to terminate.

You should be wary of long-term agreements with break clauses like those used in property lease agreements. They normally include conditional clauses which often mean the break clause cannot be triggered. One example is that all payments must have been paid o time, another is the notice period for triggering the break clause can be unduly long, and there can be many others.

While you might be familiar with agreements for office or factory premises and for company cars, plant and machinery, the above advice also applies to services including telephone hardware, telephone, mobile and broadband services, computer software, website hosting, email and IT services, office plants, hand driers, sanitary and other washroom services, alarm, security camera and guarding contracts, furniture, I have even come across concrete laid in the com car park provided under a long-term finance agreement.

When circumstances change businesses can find that being locked into a long-term agreement can turn an asset into a liability. Many long-term leasing agreements may look cheap but can become a straightjacket.

On the other hand, the asset can simply be returned if rented on a short-term basis or sold if the asset is owned. You will certainly improve your cash flow by saving the ongoing cost of rental or HP obligations and might even realise some cash.

Leave a Comment

  • (will not be published)

XHTML: You can use these tags: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>