Leasing finance: A considerable option for asset financing

MANY Small and Medium Enterprises (SMEs) struggle to purchase equipment or properties. Sometimes such struggles end to seek bank loans to acquire such assets, ending to be ultimate owners.

Since some businesses may possess little expertise in the selection of proper assets, there could be market demand where the asset needs an upgrade. Such an upgrade may be expensive or impossible.

Businesses find themselves in a situation where it has accumulated non-performing assets which reduce sales and thus, the ability to meet return to debt finance holders and shareholders. The business ends up in failure. One of the options for financing equipment or properties is leasing finance. There is a common saying that states “If you can’t lease it, don’t buy it”.

This statement encourages individuals and businesses to carefully consider their options before making a decision to purchase an asset outright and to weigh the benefits and drawbacks of leasing versus buying for their specific situation.

Leasing finance is a type of financing where a business firm or individual (lessee) rents an asset, such as equipment or property, from another party – normally a company (lessor) for a specified period of time in exchange for periodic payments. The lessor retains ownership of the asset while the lessee makes use of it. At the end of the lease term, the lessee may have the option to purchase the asset or return it to the lessor. Under this arrangement, the lessee chooses the type of equipment or property that suits its operations. Lessor is responsible for repair and maintenance costs over the lease period. At the end of the lease period, the lessee may opt to buy the asset.

Leasing finance can be used for a variety of assets, including vehicles, production lines, energy equipment such as generators, solar equipment, machinery, medical equipment, audio-visual equipment, office equipment, and real estate. Leasing is an attractive option for businesses that need to acquire assets but want to conserve cash flow and avoid tying up capital in purchasing equipment outright. Leasing finance can also offer tax benefits, as lease payments may be tax deductible, and leasing allows for easier upgrades to newer equipment without the hassle of selling and buying new assets outright.

The leasing industry in Tanzania is governed by the Leasing Act, 2016. The Act aims to regulate and promote the development of leasing as a means of financing for businesses. Key issues related to the Leasing Act in Tanzania include licensing and registration, consumer protection, security and collateral, termination and repossession, and enforcement. There are licensed companies that provide lease finance and they operate based on the legal and regulatory framework which is defined in the Act.

It should be noted that in order for the business to access lease finance, it should ensure that it meets the criteria for accessing a loan. In previous issues, we explained the details of accessing loans and the necessary steps business may consider.

Here are the necessary steps a business may take when considering lease finance:

• Ensure that your business is formal – with good financial history, clean tax, a good management team, and good internal operating systems.
• Prepare a business plan for the type of business for which you will require leasing finance. Outline the necessary requirements for the machine, its capacity, and how you will ensure you will use it to its full capacity. You will need to justify the customers for the products you will produce using the machinery or equipment. The business plan will project the monthly repayments as well as the life of the asset.
• Search for a leasing company – There are several leasing companies operating in Tanzania. Conduct an online search or by contacting a business association such as the Tanzania Private Sector Foundation. Compare rates and terms from different leasing companies to find the one that best meets your business needs. Make application.
• Based on the business plan, negotiate terms and conditions including the duration of the lease, maintenance, payment terms, and any additional fee associated with the leasing.
• Sign the lease agreement. The agreement will outline the terms and conditions of the lease, including the rights and obligations of both parties, lease term, monthly repayments, maintenance, insurance, penalties on later repayment, and the option to repurchase the asset at the end of the lease term. The leasing company may require an upfront deposit of say 20 per cent of the equipment. An upfront deposit may act as collateral or a commitment that the business will honor the asset when it is due for delivery. Some assets may take a long to deliver due to the importation or production process of the equipment manufacturer. Another important item in the lease agreement is the termination clause. The lease agreement outline condition to which the lessee or lessor can terminate the lease, before the expiry of the lease term.
• Delivery and use of the equipment: Once the lease agreement is signed, the leasing company will deliver the equipment. The leasing company may let the lessee choose a vendor for the equipment.  The equipment will be used based on the terms and conditions during the lease period.
• End of lease options: At the end of the lease term, as a lessee, you have the option to renew the lease, purchase the equipment, or return it to the leasing company.

Leasing an asset can be a good option for businesses that need to conserve cash, have short-term equipment needs, or can benefit from tax deductions. If the equipment has a short lifetime and is subject to changes in technology and upgrade, leasing also can be quite a good option. However, businesses should also consider factors such as ownership and total cost of ownership before deciding whether to lease or buy an asset.

Author: Dr Tobias Swai is a Senior Lecturer and Head of the Department of Finance at the University of Dar es Salaam, Business School. Email: tobias@udsm.ac.tz Telephone: +255 75 4300 495.