If you’re plunging into the world of equipment financing. you probably have a few questions about your options.
I’m here this morning to explain the difference between a fair market value lease and its close cousin, the operating lease. Both are used by Direct Capital and many other firms to help small businesses finance their equipment, whether that be a truck essential to your delivery company or an industrial fridge for your restaurant.
First, what the two have in common. Both are relatively short-term leases that allow for flexible payment options, for financing of the equipment in question and lower payments than a loan. Virtually any type of capital equipment can be leased with either option. That is where the similarities end.
The Fair Market Value Lease
Also known as a true lease. the fair market value lease or FMV has a residual purchase option at the end of the lease. This is important to understand when leasing a piece of equipment, and should be present in every FMV contract. In essence, when the lease is concluded the lessee can purchase the equipment for fair market value—determined by the various economic indices and the lessor—or allow the lessor to retain ownership of it.
Now, if you’re someone who needs the equipment for a relatively short period of time but doesn’t want the albatross of
ownership at the end, you can simply decline. If you’re going to need it for the future, however, you should ensure that you’re ready to determine fair market value at the end of the lease, negotiate with your financing partner if necessary and buy it outright.
It’s good flexibility to have, but it’s also important to know that you have the option when you’re done making payments on the lease.
The Operating Lease
The biggest difference with an operating lease? The ability to structure into the contract a $1 buyout of the equipment after the lease runs its course is a bonus for anyone who wants to keep that fridge or truck afterward. In many ways, this makes it the preferable option for anyone who wants to own their equipment after the lease has run its marathon course.
The operating lease also comes with a different sort of tax benefit. Where a FMV can be written off as an expense on your tax forms, an operating lease can be written off as a depreciating asset. That allows you to receive the benefits of a Section 179 tax deduction. which you can read about in more detail
So that is, in essence, the difference between the two. If you have more questions or advice for your fellow small business owners, share in the comments!