Lab Manager Magazine Article - January 2012
"To Own or Not To Own"
By: Rachel Muenz
With the current tough economy, leasing laboratory equipment could be the way to go for many labs that must now work with very tight budgets. Though leasing does carry some risk, it also has many advantages.
“An equipment lease is one of the best ways for businesses to stay ahead of the development curve,” said account specialist Brad Harmon of First Star Capital (Walnut Creek, CA), an independent direct lender whose focus is equipment leasing, including lab instruments.
He added that leasing allows laboratories to use the most up-to-date technology without having to fork over the huge initial amount of capital necessary to purchase the instruments.
“Running a lab entails making sound financial decisions that improve the condition, quality and overall competitiveness of the business as a whole,” he said, adding that leasing offers a number of other advantages, including:
- Flexibility with terms and equipment
- Conservation of working capital and credit lines
- Increased opportunities from not tying up working capital resources
- Tax benefits, such as enhanced depreciation/accelerated write-offs
- Improved financial ratios (balance sheet) with operating expense vs. liability
- Fast turnaround time compared to other forms of financing
- 100% financing typically available for established companies
As with any type of lease, however, laboratory equipment leasing does have its risks and disadvantages.
What you should be aware of
Mike Bartlett, director of global financial services at Thermo Fisher Scientific (Waltham, MA), which has its own leasing program, says there are two main risks in leasing laboratory equipment. The first is that interest rates could change after a customer has signed a lease.
Since Thermo Fisher’s leases are at a fixed rate for the life of the lease, a customer could end up paying more than necessary if interest rates drop during the term of the lease. On the other hand, Mr. Bartlett added, if interest rates rise during the lease term, the customer ends up getting a better deal with the cheaper rate they locked into at the beginning of the lease.
The second risk with leasing is that a customer could commit to the wrong type of lease, he said, meaning it’s definitely worth your while to research the various types of leases before committing. For example, a customer might sign a five-year lease-to own agreement, where they’ll end up owning the instrument after five years, but the technology changes two years into the agreement.
“They’ve decided they’d like to have the latest and greatest technology, but they’re locked into ownership of [an older model of] that particular instrument,” Mr. Bartlett said. Thermo Fisher does a number of things to prevent customers from choosing a lease that may not be the best fit for their company.
“We counteract that through different types of structures,” Mr. Bartlett said. “We have operating leases, and we have technology refresh-type offerings that are certainly available for most instruments that we sell. We try and work very closely with the customers if they do decide that they want to upgrade to that [newer] technology.”
Mr. Harmon of First Star Capital added that acquiring laboratory equipment always involves risks—such as acquiring an instrument that is inadequate or inappropriate for the lab’s needs—no matter how that equipment is funded.
“Investing in lab equipment can entail risks, all of which will be prevalent regardless of whether the equipment is leased, purchased outright with cash or acquired with any other funding option,” he said.
He suggested that lab managers who are considering leasing equipment should first think about why the equipment is needed and what the economic justification is. “If the equipment will pay for itself through cost savings/ efficiencies or by creating an additional revenue stream, it will likely strengthen the case for approval,” Mr. Harmon said.
Lab managers should also make sure they have all the relevant credit and financial information organized and ready to submit along with their application for lease approval and have at least an approximate monthly budget in mind, he said. “This [having a monthly budget handy] will allow the lesser to try and put forth the most affordable lease structure (term, payment, etc.),” Mr. Harmon said.
So many options
Anyone looking to lease laboratory equipment has a lot of choices because just about any instrument can be leased, along with laboratory furniture. Along with constantly evolving technology, the most expensive instruments also tend to be the most popular to lease, Mr. Bartlett said. “Probably the most common types of equipment are the higher-ticket items,” he said. “The more expensive the equipment, the more likely it’s going to be leased or financed.”
Such instruments include mass spectrometers, chromatography instruments and diagnostic/health equipment, Mr. Bartlett said. Mr. Harmon added that analyzers and autosamplers are also common choices for many lessees, and some larger labs sometimes acquire a LIMS through a lease. “Oftentimes, labs use leasing to secure less specialized equipment as well—assets such as computer systems, phone systems, office furniture, storage cabinets and even HVAC systems are all common,” Mr. Harmon said. The popularity of leasing lab equipment itself also varies among customers.
“It’s oftentimes a function of the customer and industry, so if you look at our healthcare customers, leasing is more prevalent than it would be with large pharmaceutical customers,” Mr. Bartlett said, adding that small labs in the environmental and biotech industries or emerging companies also tend to lease more often at Thermo.
First Star’s clients are mostly made up of established companies with stable cash flow, clientele and ownership, rather than emerging labs, Mr. Harmon said. “Young companies, such as start-ups, typically don’t have a track record of commercial credit, thereby making it difficult to qualify for lease funding approval,” he explained. “Furthermore, labs with established clientele and stable cash flow are typically better positioned to forecast equipment needs, asset life cycles and manageable monthly payment obligations.”
Mr. Harmon said that, in general, lease contracts are usually around 24 to 60 months at First Star, and end-of-term lease options vary depending on whether the lab has a capital lease or a true lease.
“A capital lease allows for a ‘bargain purchase option’ at the end of the term, such as $1 or a fixed percentage of the original acquisition cost (oftentimes 10 percent), while a true lease allows more flexibility, including the option to return the equipment and walk away, renew the lease for 12 additional months at a discounted rate or purchase the equipment for the depreciated fair market value,” he said.
Thermo Fisher also offers $1 and fair-market-value purchase options with payment structures of 12 to 60 months and a variety of other payment options. The leasing division also offers master lease line of credit, reagent agreement, future funds and emerging-credit lease options for development stage companies— all of which are explained further on their website.
Mr. Bartlett said, however, that the traditional capital lease remains the most popular leasing program at Thermo Fisher and most of their customers’ leases are three-to-four-year terms, while about 75 percent of those customers look to own the instruments at the end of the lease.
Customers who deal with changing technology prefer the operating lease structure, he added, explaining that operating leases have a shorter two-to-three-year term and customers don’t own the instrument at the end but have the options to purchase, continue to lease or upgrade to the newest version of that instrument.
“We see cases where technology changes every 18 to 24 months, and so for those customers—such as pharmaceutical customers and some of the top academic research institutions—they always want to maintain the latest technology in their labs, so they would look for that [operating lease] program,” Mr. Bartlett said.
Laboratory equipment leases can also include a maintenance/service option if the customer wishes it. Because Thermo is also an equipment manufacturer, what is known as a captive leasing company, it also provides maintenance for its leased equipment, Mr. Bartlett said.
“If customers want to add an extended service contract, then we’re happy to include that on the lease,” he said, adding that most of the equipment Thermo sells comes with a one-year warranty. For those who decide to add service to their lease, it’s simply added to their payment at the end of the month, Mr. Bartlett said, and Thermo also has a reagent rental program that bundles consumables/reagents, equipment and service into one payment per month.
While First Star is not an equipment manufacturer, it can also include service/maintenance agreements in its leases if customers ask for them, Mr. Harmon said, adding that “soft costs,” such as service and maintenance, should be less than 20 percent of the total transaction size. He added that while the lease is done through First Star, the maintenance aspect would be handled by the original manufacturer
“The equipment manufacturer/supplier would simply include this as a line item on the invoice so that it is paid for in conjunction with the equipment acquisition,” he explained. “The service/maintenance agreement is then paid for and subsequently administered by the manufacturer or an authorized technician of some sort—the logistics of this are handled by the equipment supplier and the lessee / end user of the equipment.”
Current leasing trends
Despite the cost savings leasing can provide, the recession has made it tough for smaller laboratories to get loans from banks and other traditional lending agencies because they have been forced to do some belt tightening, according to both Mr. Harmon and Mr. Bartlett.
That’s meant a drop in demand over the past few years at lending companies such as First Star, Mr. Harmon said. “On the lending/extension of credit side, there was a flight to quality combined with a sometimes pronounced tightening of credit approval criteria,” Mr. Harmon said. “This, combined with an overall deterioration in credit quality, contributed to the environment of lower equipment investment / lease volume.” However, he said things have been looking up recently.
“In general, the demand for an extension of credit has decreased during the recession, although a clear recovery is under way with the trends pointing upward in 2011 and going into 2012,” he said. On the other hand, laboratories’ difficulty in getting loans at banks and other leasing companies due to new restrictions has meant a recent increase in business for Thermo Fisher’s leasing division, Mr. Bartlett said.
“Our business this year on the finance side is up, I would say, approximately 35 percent over the last year,” he said, adding that concern about the economy has also driven that increase. The company’s reagent renewal program and its technology refresh program, which was just rolled out in 2011, along with various payment structures have also helped grow Thermo’s leasing business, Mr. Bartlett added.
“We try and really look at the customer’s needs, understand the challenges they’re facing today and put the right program in place,” he said. “Through the efforts of the team here, [we’ve] done a very good job in understanding what those challenges are and making sure that we have the right program to offer.”