[NOTE: This is another in the series of repostings of my previously-published articles. I first wrote about technology leasing for law firms in the late 1990s in my Lawyers Weekly USA column. I revisited the subject in 2004. I'm intrigued by the opportunities leasing can create to reach higher and farther when implementing technologies. You may decide against leasing, but it's always a good idea to "run the numbers" and consider leasing as an option.]
Keeping Pace While Keeping Your Cash Flow: Technology Leasing for Lawyers
Remember the first time that you realized that the reason your neighbor was driving a new BMW was not because he was embezzling money from his employer but because he was leasing the BMW? Now we take for granted that many people with new cars are leasing them, in the process changing attitudes toward leasing and the culture of ownership.
The next time you notice an opposing party with another new notebook computer or a competitor law firm with all new hardware, you might be seeing evidence of the movement of technology leasing into the legal profession.
The adoption of technology leasing by lawyers and law firms should not surprise you. Many small businesses lease technology as a common practice. Some have suggested that as many as 80% of all businesses use or have used technology leasing to one degree or another.
The New Popularity of Technology Leasing for Law Firms
Computer technology is an attractive area to consider leasing. Computer systems get outdated quickly. There are good reasons to keep pace with technological change. Experts consistently recommend replacing computers on about a three-year schedule. After three years, the typical computer has little or no market value and will no longer be covered by warranty. Hardware costs, especially for servers, add up quickly and may require large cash outlays for new purchases.
The combination of these factors creates a situation that is similar to the new car sales business before leasing became so prominent. As a result, many individuals have started to look for comparable leasing opportunities for computer systems.
A new car lease is an excellent analogy when considering technology leasing. There are financial aspects of the decision – effective rates, time value of money, total costs, and the like. There are economic considerations – cash on hand, available credit, and the like. There are needs factors – potential growth, future requirements, likely usage, and the like. Finally, there are some X factors – “moving up” to a platform you can’t afford to buy, having newer and better equipment, meeting prestige or other requirements, simply getting what you want, and the like.
While there are some people who can make the lease vs. buy decision purely based on financial factors, most of us will make the decision as a result of a more complex dynamic.
The good news is that many creative leasing options are available to small businesses and individuals, one or more of these options may make good economic sense for you, and the so-called “smart leases” or “value leases” extend the benefit of leasing by, in certain cases, letting you bundle hardware, software and consulting services into a single monthly payment.
If you strip the business of a law practice of all the subtleties, we are ultimately in a cash flow business. The main goal of both a new firm and an existing practice is to reach and maintain a positive cash flow. In that light, technology leasing deserves a close look as a way to spread out expenses and create a more predictable cash flow, in addition to the benefits of keeping you current on technology.
Leasing is especially attractive to law firms that want to stay closer to the cutting edge in technology and to smooth out their cash flow and to protect their working capital while avoiding large periodic expenses for the purchase of new technology.
Technology as a Utility Cost and Other Financial Considerations
Legal technology consultant, Bill Coplin, in St. Louis, Missouri, explained the benefits of leasing to me quite a few years ago and the same principles still apply today. His approach goes to the root of the issue. He believes that leasing allows law firms to “fix their costs per seat” for technology on an ongoing basis. But he goes further than that and says, “All firms should begin to look at computer costs as utility costs and not capital costs.” A lease allows you to stay at an appropriate level of technology for a set monthly cost that you can budget for in advance.
However, the lease analysis is often far less sophisticated or subtle. Studies are consistently showing that technology expenses have grown to roughly 5% to 6% of the total expenses of the average law firm. At these levels, paying cash may no longer be a viable option. Even firms that traditionally only pay cash or wait to purchase technology until the proverbial “good year” will look at leasing options today once they see the dollars required for a purchase and factor in software, training, support and other services. Often those firms will cut costs and cut corners on other parts of the package, most often training, and not realize all the hoped-for benefits of a technology upgrade. Sometimes this approach is known as being penny wise and pound foolish.
The “smart” leases give you a way to roll services, hardware and software into your monthly lease payment. This type of bundling allows a firm to consider an appropriate monthly cost of technology and reach a little higher on hardware, while not cutting corners on training and support. For example, a bundled lease may even provide a way for a smaller firm to afford a high-level consulting firm, better software or a robust network infrastructure.
Can you just walk into a leasing company and expect to obtain a lease? Not necessarily. You still have to show credit-worthiness. Be aware that some technology leasing companies may require more financials than a small or new law firm can provide. On the other hand, vendors such as Dell, HP, Microsoft and others offer leasing options to their small business customers as a standard option and may prove to be better alternatives for certain firms. In each case, however, leasing companies and vendors will probably more willing to work with you than traditional banks.
The Leasing Mentality
In many law offices, the newest and best technology can be often be found in the copiers, which are typically the only pieces of equipment a firm is leasing. Lawyers, however, tend to think of computers as capital costs or as equipment that they must own. Are copiers really so different?
A lessee is a user, not an owner. We often are caught up in the notion of ownership. However, in the case of the office itself, copiers and our cars, we are quite comfortable with leasing. Technology leasing requires a similar approach, or a “leasing mentality.”
In other words, if you are currently leasing your car, you may be very receptive to leasing your computer. If, on the other hand, you are proud of telling people that your car has 150,000 miles on it and you haven’t yet noticed that you tend to start out many conversations with “my mechanic was saying the other day …”, you may have more difficulty.
As a general rule, younger lawyers, lawyers starting a solo or small firm practice and lawyers with small bank accounts will tend to have a leasing mentality.
Leasing Advantages and Disadvantages
Advantages of leasing include:
- Reduce your initial investment and capital expenditures
- Spread out your technology costs over time
- Make your technology costs more predictable for budgeting and other purposes
- Give you favorable tax treatment in certain cases
- Make it easier for you to upgrade computers and systems
- Allow you to bundle software and services costs into monthly lease payment
- Reduce the impact on your cash availability and credit limits
- You may be able to qualify for a lease more easily than for a loan
- Lessor handles disposal of old equipment
- Offers you better terms than available for bank loans or other financing
- Gives you the convenience of one-stop shop
- You do not own your equipment
- Potentially larger total outlay of funds over the term of the lease
- Cancellation fees will likely apply if you want to get out of a lease
- Leases may not be assignable or contain other onerous provisions
- Financial viability of lessor may affect your lease arrangement
- Make it too easy to add additional equipment
- If not carefully crafted, you may not get desired tax benefits
- Leases may be based on prices for equipment substantially higher than what you could buy the equipment for
- Actual finance rate may be quite high
- In the case of vendor leases, becoming “captive” to one provider
Getting Your Toes Wet
Some law firms test out the idea of leasing with notebook computers before moving to leasing desktop computers. The duration of leases for notebooks is typically eighteen to twenty-four months, while leases for desktop computers typically last twenty-four to thirty-six months.
Leases can be creative, customized and flexible. A leasing arrangement may involve a master lease schedule with a phase-in of equipment. Another type of lease might allow you to add equipment on an as-needed basis and simply incorporate new items into the lease arrangement.
As mentioned above, leasing companies, hardware vendors and some consulting firms can put together a package that includes hardware, software and consulting services into a single monthly lease payment. Some leasing companies, however, may require a fixed percentage of the lease to be based on the hardware.
Another good starting point to experiment with leasing is with a new network server. I know of several lawyers who received quotes for the server set-ups they wanted that greatly exceeded what they had budgeted for all technology costs. Buying a server is far more than simply buying the “box.” As a result, firms often cut corners on memory, backup, redundancy and other important features when they make the initial purchase and try to eke more service out of badly outdated servers as replacement time approaches. Given the vital importance of stable and well-run networks to today’s law firm, these approaches create vulnerabilities at precisely the place you want to be strongest. A lease arrangement for your server will let you experiment with the leasing concept in a limited way, but allow you to take advantage of cost-spreading and other benefits of leasing to help you get the sufficient and reliable network infrastructure you need.
End of Lease Options
What happens at the end of a lease? Despite the available purchase option, the purchase of three-year-old, heavily-used equipment at the end of a lease term is relatively uncommon. Typically, a lessee will simply order new replacement equipment and have the lessor take away the old equipment. In other cases, the lease term is simply extended with the monthly payment kept the same for any new equipment. In effect, the lease never ends. The lessee will typically be working with the leasing company well in advance of when the lease term expires to work out the various options for bringing in a new technology package.
By working under a master lease agreement or by staggering the terms of multiple leases (sometimes referred to as “layered leases”), you can get the new equipment you need when you need it without ever incurring a large capital investment for purchasing equipment. In some cases, you might even upgrade all of your equipment with no change in your monthly cash outlay for technology.
A lease also eliminates the growing concern about how to dispose of old computers properly. The leasing company will take back your computers and handle disposal. On the other hand, it is vital that you have your data “wiped” or electronically “shredded” from hard drives before turning computers back to the lease company.
Leases, especially those that bundle hardware, software and services, raise a number of tax issues. I want to highlight two key points about taxes.
First, there are some significant tax consequences arising out of the different methods of leasing. Consulting with your tax advisor before entering into a lease is highly recommended, especially since tax laws relevant to the leasing decision have changed recently. One reason to use a computer leasing company is the expertise it will probably have on tax issues and its experience and flexibility in structuring leases. As a general matter, you will want an “operating lease” rather than a “capital lease” and a fair market value end-of-lease purchase option rather than a $1 end-of-lease purchase option. Bundling software and services into a hardware lease may also have significant tax consequences.
Second, calculating the relative costs of buying vs. leasing accurately requires that you consider the impact of taxes and time value of money. Simply adding up the total of all lease payments and comparing it to the cash payment required will not give you accurate information upon which to make a decision. In addition, changes in Section 179 that raised the total amount of equipment that can be expensed in the first year of a business may lead to completely different financial conclusions for a start-up and an ongoing firm.
Evaluating Leasing Companies
As I suggested above, entering into a leasing arrangement will probably result in a long-term business relationship. In doing your due diligence on a leasing company, look closely at:
- The length of time a leasing company has been in business and its reputation in the market.
- The leasing company’s financial strength and credit-worthiness.
- Does a firm keep its financial paper? A company that services its own leases is preferable to a lease broker.
- The expertise of the leasing representative.
- Are there hidden costs, such as closing costs, “documentation fees,” or other service charges?
- The administrative abilities of the lessor, particularly its record of paying vendors on time. A leasing company with a bad record with vendors may make those vendors less willing to work with you.
- Knowledge of the legal business. A leasing company with expertise and experience in the legal industry should be able to come up with more creative options and customize a leasing arrangement for you, with a greater sensitivity to lawyers’ concerns.
Key Terms in Leases
Once when leasing a car, I had a salesperson ask me if, as a lawyer, I wanted some time to read all the provisions carefully. I said, “Will we be able to change anything I don’t like?” Sheepishly, the salesperson said, “I really doubt it.” I suggested that, in that case, it probably wasn’t an effective use of my time to do a complete review of the lease agreement.
In some cases, you or your firm will have limited, if any, flexibility in negotiating a technology lease. In other cases, you may have enough leverage to get some concessions.
Here are a few provisions to pay attention to:
- Duration of lease – is it appropriate for the leased equipment?
- Total cost of lease and all additional charges
- Cancellation options and penalties
- Assignment provisions for both you and the lessor
- Automatic renewal provisions
- Permissible rate increases
- Ability to exchange or update to more modern equipment
- Service or maintenance charges or plans, especially mandatory plans
- Contract language required for desired tax treatment
- Consider the bundling option. Interestingly, a hardware vendor, a software vendor or a consultant may each have the ability to combine hardware, software and services into a single lease payment. Ask each of them what options are available.
- A diversified approach makes the best sense. A combination of leases, purchases, durations and providers will often produce the best overall results.
- If you are committed to certain providers, the convenience of dealing with one arrangement may outweigh other benefits of diversification for you. But be sure to revisit this issue from time to time.
- Learn about leasing options from websites and other resources before you ask about them.
- Proceeding as if you will make a purchase and arriving at a final price before announcing that you want to consider leasing may result in better pricing.
- Leasing will work best for you if you use it as a weigh to upgrade and keep current your technology.
- If you do not have a leasing mentality or cannot see technology as an ongoing monthly cost of doing business, much like a utility, reduce your stress and stay in your comfort zone by continuing to purchase equipment. However, remind yourself that you may give up competitive advantages to stick to your old ways.
- Keep in mind the powerful impact leasing can have on your cash flow and consider whether leasing will enable you to free up money for needed other investments in people, marketing or other areas. What are the opportunity costs of using large amounts of cash for technology purchases? What else might you do with that money? Why not use leasing as a way to do both?
- Make sure that you understand the lease arrangement and that the lease agreement actually reflects what your arrangement is.
Clients are putting pressure on firms to keep current with technology. Once a firm spends a significant amount of money on computers, there is a reluctance to make the same kind of cash outlay within a few years. As a result, firms have a tendency to hang on to outdated technology or to cut corners on training and support.
For existing firms, leasing offers a path to make those upgrades and maintain a good technology platform without making significant capital expenditures every few years. For new firms and solos, leasing offers a great way to reduce initial start-up costs, acquire enough technology to create a competitive advantage, and create a positive cash flow.
The advantages and disadvantages of leasing may result in firms reaching different conclusions for different technology at different times, so it is important to analyze the leasing option carefully each time and not make a permanent decision always to buy or always to lease. In many cases, a mixed approach to buying and leasing will make good sense. The path to avoid is the one that avoids any consideration of leasing at all. If you are starting a new firm, however, technology leasing, including bundled arrangements, may be one of the wisest decisions you make.
[Originally posted on DennisKennedy.Blog (http://www.dennskennedy.com/blog/)]
This post brought to you by Dennis Kennedy’s legal technology consulting services, featuring RSS and blogging consulting, technology audit, strategic planning and technology committee coaching packages especially for medium-sized law firms (15 – 100 lawyers) and corporate legal departments. More information on the “Second Pair of Eyes” packages for legal technology audits and strategic planning may be found here (PDF).