What Leasing vs Buying may say about you - An Investor's Perspective

While the article is about IT, it applies to a wide range of capital acquisitions.

By Vikal Kapoor of EquityNet

When a fellow investor was apparently unhappy with the answer of the entrepreneur pitching his company’s funding need, I found myself asking my compadre for clarification to his previous question (something the small business owner probably should have done, when all is said and done). “We have been fortunate enough to be able to purchase all of our technology; and therefore, have not needed to lease any of our hardware or software...” was the response from the CEO of a small manufacturing firm seeking $1.5M to expand his clientbase in the defense industry.

What I too thought was a decent and standard answer from the business owner to the question from the investor - a former Private Equity executive who invests in US small businesses seeking between $500,000 and $2Million, according to his EquityNet Investor profile, clarified that his original question: “How long have you been leasing your technology?” provides him with great insight into how efficiently Management runs the company.

Some context: We were 4 investors on the call, located in as many US cities, from different backgrounds (private equity, debt capital markets, retired entrepreneur who is considered a High Net Worth individual and advisor for family offices) all of whom met each other on EquityNet and were introduced to the profile and CEO of the small manufacturing co. This was our first call after reviewing their initial documents. And, as I left off, it was turning out poorly for the CEO and he didn’t even know it.

So once I realized that the private equity investor had become disinterested and would email the group after the call with the standard “Pass,” I felt I should help out seeking some clarification.

The investor shared that efficient companies are run by efficient entrepreneurs. Leasing, rather than buying hardware and software, freed up capital at his previous investments, thereby, allowing those companies to reinvest in money-making aspects of the business. The ROI on those investments was always higher than at firms that insisted on owning and maintaining their technology. After the call, I began to compare notes with him. As a former Turnaround CEO, I realized my framework was missing the lease vs buy analysis of our hardware and software.

He explained to me that technology equipment goes stale faster than expected and is almost always exceeds budget forecasts to maintain, upgrade and service. We quickly got to employee productivity and whether the benefits of investing in the latest hardware and software were worth the increase in employee productivity (profit/employee variable that Private Equity folks calculate during turnaround and aggressive growth companies, alike.) He explained that if a business can find a good technology leasing company, the small business can set terms to upgrade to the latest hardware and software - and service them with well-trained IT professionals, more often than if the company owned it all outright.

In fact, we both realized we were naturally trained (aka- scarred!) to look for companies that reinvested profits for money-making activities (ROE and ROI) such as client-facing sales activities, including hiring top salespeople with incentive-based compensation plans, negotiating with suppliers to pay them later in order to cover outstanding accounts receivables. Of course, like most small business investors, we were inclined to invest our time and dime (brain power and capital) with entrepreneurs and businesses where our support helps the company grow. But what does “investing behind growth really mean?” We began to discuss how a multitude of companies seeking advice, guidance, support and of course, capital, were deploying new funding in old ways.

We concurred that many entrepreneurs we came across were married to “liabilities that were masquerading themselves as depreciating assets.” These bottomless pits were sucking critical capital resources but failing to generate much needed revenues for the business. All of a sudden, technology, such as hardware and software that require ongoing and less predictable maintenance costs, became the most obvious example to me.

So I decided to put these investor and executive insights out there for small business owners to hopefully learn from. Lastly, I made and attached a quick chart for this new way of thinking about your own business. Hopefully it helps you determine the potential material impact of owning vs leasing technology.

Benefits of Leasing IT

• Improve liquidity in the near-term by financing the entire IT costs (hardware, software and soft costs like services, installation and taxes)
• Improve alignment of sales/profits with costs. Be able to create provisions for sales cyclicality.
• Improve your funding chances because of better balance sheet management. Operating leases do not appear as debt on your financial statements, because they are not considered a long-term debt. Thus, it makes the business more operationally attractive to lend to.
• Match your IT budget to the business. Leasing allows you to expand, renew, add and upgrade IT when the business needs it rather than investing everything upfront.
• Reduce operational risk of the business. Because IT does go stale and need to be maintained and serviced (like all machines), any interruption will affect the company’s operations. Leasing IT also means that you’ve successfully outsourced the repairs, maintenance and general operations of the hardware and software. This solution also reduces loss in productivity that maintenance and stale IT.

Small business owners should always be introspective on how all resources are used to fuel growth.  Leasing IT infrastructure could give the business immediate liquidity.  There is a cost-benefit for buying vs leasing software, hardware, outsourcing the desktop and creating better virtualization environments for the company’s to more aggressively grow upon. The extra cash could fill a funding gap, make the firm more financially healthy and allow the business owners to invest more in growth while better managing its balance sheet by aligning costs with revenue expectations. As my fellow investor helped me realize, we look to invest in people ahead of processes. Small business owners best demonstrate their true worth by the efficiencies created in their business.

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