To Lease or Not to Lease

Note: This sponsored article is written by Kemp Anderson with Kemp Anderson Consulting. To read more about Kemp Anderson or to schedule a free consultation, click here. 

Fleet leasing can be a great idea or a poor idea for a pest operator depending on factors such as financial goals, operational needs, risk tolerance and how long you intend to own your company. It is critically important that you consider the impact of vehicle leases on a potential sale. Over ninety percent of acquisitions in the pest control industry are structured as asset purchases and leases are characterized as liabilities. How will vehicle leases impact your purchase price and terms if the buyer refuses to assume the leases? Let's break down some considerations:

First remember that leases are legal documents. They are legally and can have profound business and financial implications, both short and long term. Attorneys and CPAs (Certified Public Accountants) should play critical roles in reviewing and evaluating leases before you agree to them.

• Legal Implications: Leases outline the rights, obligations, and responsibilities of both parties involved - the lessor (the leasing company) and the lessee (the business owner). Your attorney should review the lease to ensure that the terms are fair, legally sound, and protect the interests of the business owner. Attorneys will also identify any potential legal pitfalls or ambiguities in the contract that might lead to future disputes and potentially harm the business.
• Financial Implications: Lease agreements often in corporate complex financial terms, including lease payments, interest rates, fees, and penalties. Your CPA will analyze these financial aspects of the lease to ensure that the terms align with the business's financial goals and objectives. They can also assess the long-term financial impacts of the lease, including the total cost of leasing versus purchasing, and the projected impacts on your business's cash flow and profitability.
• Tax Considerations: Vehicle leases also have significant tax implications for businesses, including deductions for lease payments, treatment of lease expenses, and potential tax consequences upon lease termination or asset disposition. Your CPAs will provide valuable insights into the tax implications of the lease and assist you in maximizing tax benefits while ensuring your compliance with tax laws and regulations.
• Risk Management: Your Attorneys and CPAs will also assist you in identifying and mitigating risks associated with leasing, such as liability issues, insurance requirements, default provisions, and options for terminating the leases. By carefully reviewing the lease agreement, Attorney and CPAs can advise you on ways to minimize risks and protect your interests.
• Negotiation Leverage: Attorneys and CPAs can assist you in negotiating more favorable terms and conditions in the lease agreement. They can identify areas where concessions can be made, or additional provisions added to better align the lease with the business's needs and objectives.

 Having your attorneys and CPA review your leases before you sign them is essential to ensure that the lease is legally sound, financially favorable, and adequately protects the business's interests. Their expertise can help you navigate complex lease terms, mitigate risks, and maximize the benefits of leasing for your business.

Positive factors of fleet leasing for a pest control company:

1. Cost Management: Leasing can provide predictable monthly payments, making it easier to budget for fleet expenses compared to outright purchasing, which can have unpredictable costs associated with maintenance and depreciation.
2. Access to Newer Vehicles: Leasing allows companies to regularly upgrade their fleet, ensuring access to newer, more fuel-efficient, and safer vehicles without the hassle of selling off older vehicles.
3. Reduced Administrative Burden: Leasing typically includes services such as maintenance, roadside assistance, detailed fleet tracking including metrics and administrative tasks like registration and licensing, which can save time and resources for the company.
4. Tax Benefits: In many cases, lease payments may be fully deductible as a business expense, offering potential tax advantages. Again, consulting with your CPA is highly recommended.
   

Negative factors of fleet leasing for a pest control company:

1. Long-Term Cost: Over the long term, leasing can be more expensive than purchasing, as the company does not gain ownership of the vehicles at the end of the lease term. Further, the leasing company may direct when the vehicles must be replaced.
2. Mileage Restrictions and Penalties: Leases often come with mileage restrictions, and exceeding these limits can result in costly penalties. Conversely, when you have a leased vehicle with low miles you may still be required to update or replace it.
3. No Equity: Unlike purchasing, leasing does not provide value in the fleet compared to purchasing vehicles. You do not have any vehicle assets to show for the payments made. You will also have an ongoing financial obligation that you will need to address if/when you consider selling.
4. Restrictions on Customization: Leasing contracts typically prohibit significant modifications or customizations to the vehicles, which may not be suitable for companies with specific operational needs.
   

What is an open-ended lease?

An open-ended lease, also known as a finance lease or a capital lease, is a type of lease where the lessee (the company) assumes the risks and rewards of ownership. At the end of the lease term, the lessee typically has the option to purchase the asset at its fair market value. Open-ended leases are often used for financing the acquisition of assets like vehicles or equipment.

What is a residual payment?

A residual payment, also known as a residual value or balloon payment, is a lump sum payment made at the end of a lease term in a lease agreement. This payment reflects the estimated value of the leased asset at the end of the lease term. It is commonly associated with leases where the lessee assumes the risk of ownership, such as finance leases. The residual payment allows the lessor to recover a portion of the asset's value and can lower the lessee's monthly payments during the lease term.

A closed-end vehicle lease, also known as a walk-away lease or a fixed-term lease, is a type of lease where the lessee (the business owner) returns the vehicle to the lessor (the leasing company) at the end of the lease term without any further financial obligations, provided the vehicle meets certain predetermined conditions regarding wear and tear, mileage, and maintenance.

Business owners should be concerned about closed-end leases for several reasons:

1. Potential Penalties: Closed-end leases typically have strict guidelines regarding mileage limits and vehicle condition at the end of the lease term. Exceeding mileage limits or returning the vehicle with excessive wear and tear can result in costly penalties for the lessee.
2. Limited Flexibility: Unlike open-ended leases or purchasing, where the lessee has the option to buy the vehicle at the end of the lease term, closed-end leases generally do not offer this option. This lack of flexibility can be a concern for businesses that may want to retain the vehicle or extend the lease.
3. Cost Considerations: While closed-end leases may offer predictable monthly payments and reduce the administrative burden associated with vehicle ownership, they can be more expensive over the long term compared to purchasing or open-ended leases. This is because the lessee does not build any equity in the vehicle and is essentially renting it for the lease term.
4. Residual Value Risk: In closed-end leases, the lessor assumes the risk of the vehicle's residual value at the end of the lease term. If the actual market value of the vehicle is lower than the predetermined residual value, the lessor may incur a loss. This risk is typically factored into the lease payments, but it's still a consideration for business owners.
5. End-of-Lease Process: Business owners need to carefully manage the end-of-lease process, including arranging for vehicle inspections, returning the vehicle on time, and ensuring compliance with lease return requirements. Failure to adhere to these requirements can lead to additional charges and complications. You may need assistance and guidance from your attorney at the end of your lease.
   

How leases are accounted for in an asset purchase:

In an asset purchase, vehicle leases will typically be handled independently from the asset purchase agreement. The lease terms and conditions, including payment schedules, maintenance responsibilities, and termination clauses, will be outlined in a separate lease agreement. The company will make regular lease payments to the lessor (the leasing company) as per the terms of the lease agreement. Often the buyer will require the seller to pay off the lease obligations either prior to closing or out of the closing proceeds (purchase price). While the handling of vehicle leases will always be negotiable, it will also further complicate the negotiations of the acquisition and may also delay the closing. It may be necessary for the buyer or seller to engage in further negotiations with the leasing company. The leasing company may not be cooperative in those negotiations.

In summary, pest control operators should carefully weigh the terms and conditions of vehicle leases and fully evaluate the potential risks and costs involved before entering into such agreements. The failure to do so may result in unanticipated liabilities and a reduction in the purchase price for their business.