Equipment Leasing Terminology
Liberty Capital loves to empower business owners with knowledge so they can make better educated decision. Our goal is to bring it to you helpful resources that is tangible impactful to you. Creating a comprehensive glossary for equipment leasing and financing and beyond, including related IRS terminology, business laws with common sense approach can be very helpful for understanding the industry. Afterall, most people lease or finance to maximize deductibility based on how each interpret IRS rules.
Common terms and their definitions every business owner should know:
IRS and Accounting Terms
- Capital Lease (Finance Lease): A lease that is treated as a purchase by the lessee for accounting purposes. It must meet one of the following criteria:
- Transfer of ownership at the end of the lease term.
- Bargain purchase option.
- Lease term is 75% or more of the equipment’s useful life.
- Present value of lease payments is 90% or more of the equipment’s fair market value.
- Operating Lease: A lease that does not meet the criteria for a capital lease. It is treated as a rental agreement for accounting purposes, with lease payments being expensed as incurred.
- Section 179 Deduction: A tax deduction allowing businesses to deduct the full purchase price of qualifying equipment purchased or financed during the tax year, up to a certain limit.
- Depreciation: The allocation of the cost of the equipment over its useful life.
- Amortization: The process of gradually paying off a debt over time through regular payments.
- Interest Rate: The percentage of the principal charged by the lender for the use of its money.
General Equipment Leasing Terms
- Equipment Lease: A contractual agreement where the lessor (owner) allows the lessee (user) to use the equipment for a specific period in exchange for periodic payments.
- Lessor: The party that owns the equipment and grants the lease.
- Lessee: The party that uses the equipment under the lease.
- Lease Term: The duration for which the lease agreement is valid.
- Lease Payment: The periodic payment made by the lessee to the lessor for the use of the equipment.
- Residual Value: The estimated value of the equipment at the end of the lease term.
- fair Market Value (FMV) Lease: A lease where the lessee has the option to purchase the equipment at its fair market value at the end of the lease term.
- $1 Buyout Lease: A lease where the lessee can buy the equipment for $1 at the end of the lease term.
- 10% Purchase Option Lease: A lease where the lessee can purchase the equipment at 10% of its original cost at the end of the lease term.
- Lease Rate Factor: A multiplier used to calculate the monthly lease payment based on the equipment cost.
- Equipment Loan: SImilar to a lease but a loan similar to equipment finance agreement.
Types of Leases
- True Lease: Another term for an operating lease where the lessee does not assume the risks and rewards of ownership. Buyout must be over 90% of the current present value.
- TRAC Lease (Terminal Rental Adjustment Clause): A type of lease commonly used for vehicles where the lessee and lessor agree on a set residual value, with adjustments made at the end of the lease term based on the vehicle’s actual market value.
- Sale-Leaseback: A transaction where the owner of equipment sells it to a lessor and then leases it back. This can free up capital for the original owner.
- Leveraged Lease: A lease where the lessor finances a portion of the equipment cost through a third-party lender.
Rental Purchase Option: Earn equity on equipment rental toward purchase.
Equipment Finance Agreement (EFA) Terms
- Equipment Finance Agreement (EFA): A loan used to purchase equipment, where the borrower owns the equipment and the lender has a security interest in it until the loan is repaid.
- Down Payment: The initial payment made by the borrower towards the purchase of the equipment.
- Term Loan: A loan for a specific amount with a specified repayment schedule and a fixed or variable interest rate.
- Balloon Payment: A large payment due at the end of a loan term after a series of smaller periodic payments.
- Collateral: The equipment itself, which serves as security for the loan.
Additional Terms
- Credit Approval: The process by which a lender assesses the creditworthiness of a borrower before issuing a loan or lease.
- Personal Guarantee: A promise made by an individual to repay the debt if the business fails to do so.
- Soft Costs: Costs related to the equipment acquisition that are not directly tied to the equipment’s purchase price, such as installation and training.
- Hard Costs: The direct purchase cost of the equipment.
- Default: Failure to meet the terms of the lease or loan agreement, such as missing payments.
- Repossession: The act of taking back the equipment by the lessor or lender if the lessee or borrower defaults.
- Lien: A legal claim against the equipment as collateral for the loan or lease.
Financial Metrics
- Net Present Value (NPV): The value of all future lease or loan payments, discounted back to the present value. TIME VALUE OF MONEY. A MUST KNOWLEDGE FOR EVERY BUSINESS OWNER. LEARN IT!
- Internal Rate of Return (IRR): The rate of return used in capital budgeting to measure the profitability of investments.
- Lease Utilization Rate: The percentage of leased equipment that is in active use.
Financial and Administrative Terms
- Early Payoff Discount: A reduction in the total amount owed if the lessee or borrower pays off the lease or loan before the end of the term. This incentive encourages early repayment.
- Down Payment: The initial amount paid by the borrower at the start of a lease or loan agreement. It is usually a percentage of the total cost of the equipment.
- Advance Payment: Payments made at the beginning of the lease term, which may include the first month’s payment, a security deposit, or other upfront fees.
- Administrative Fee (Admin Fee): A fee charged by the lessor or lender to cover the administrative costs associated with processing the lease or loan.
- Origination Fee: A fee charged by the lender to process a new loan or lease, often expressed as a percentage of the total amount financed.
- UCC-1 (Uniform Commercial Code-1): A legal form filed by a creditor to give notice that it has an interest (a lien) in the personal property of a debtor (lessee or borrower). This form is used to establish the priority of the lender’s claim.
- UCC-3 (Uniform Commercial Code-3): A form used to amend or terminate a UCC-1 filing. It can be used to continue, assign, or terminate the lien.
- Judgment: A court order that determines the outcome of a lawsuit. In the context of financing, it can refer to a legal decision requiring the borrower to pay a debt or fulfill a financial obligation.
- Tax Liens: Claims imposed by the government on a property when the owner fails to pay taxes owed. In equipment financing, it can affect the borrower’s creditworthiness and the lender’s security interest.
- Credit Report: A detailed report of an individual’s or company’s credit history prepared by a credit bureau. It is used by lenders to assess creditworthiness.
- Amortization: The process of gradually reducing a debt over time through regular payments of principal and interest.
- Time Value of Money (TVM): The concept that money available now is worth more than the same amount in the future due to its earning potential. It reflects the opportunity cost of not having the money invested.
- Factor: In finance, a factor is a financial intermediary that purchases receivables from a company, providing immediate cash flow. In leasing, it can refer to the lease rate factor.
- Factor Rate: In merchant cash advances, the factor rate is a multiplier used to calculate the total repayment amount, different from an interest rate. It is expressed as a decimal (e.g., 1.2 for a 20% cost of capital).
- Lease Rate Factor: A multiplier used to calculate the monthly lease payment based on the equipment cost. It is used to simplify the calculation of lease payments.
- Compounding: The process of generating earnings on an asset’s reinvested earnings. In finance, it refers to the calculation of interest on both the initial principal and the accumulated interest from previous periods.
- Cost of Capital: The cost for a company to fund its operations and growth, typically expressed as a percentage. It includes the cost of debt and the cost of equity.
Business Law and Structure Terminology
- Contract: A legally binding agreement between two or more parties that creates obligations enforceable by law. Contracts can be written, oral, or implied.
- Business Structure: The legal organization of a business, which determines how it operates, is taxed, and its legal liabilities. Common structures include sole proprietorships, partnerships, limited liability companies (LLCs), and corporations.
- Sole Proprietorship: A business owned and operated by one person. The owner has full control, receives all profits, and is personally liable for all business debts and obligations.
- Partnership: A business structure where two or more people share ownership. Partners share profits, losses, and management responsibilities. There are different types of partnerships, such as general partnerships and limited partnerships.
- General Partnership: A partnership where all partners share equally in management responsibilities and liability.
- Limited Partnership (LP): A partnership with both general partners (who manage the business and have unlimited liability) and limited partners (who invest in the business but have limited liability and do not participate in management).
- Limited Liability Company (LLC): A business structure that offers limited liability protection to its owners (members) and flexible tax options. It combines elements of partnerships and corporations.
- Corporation (Inc.): A legal entity that is separate from its owners (shareholders). Corporations offer limited liability protection, can raise capital by issuing stock, and are subject to corporate taxation.
- C Corporation: A standard corporation that is taxed separately from its owners. It can have an unlimited number of shareholders and is subject to corporate income tax.
- S Corporation: A special type of corporation that allows profits to be passed through to shareholders’ personal income without being subject to corporate tax. It has restrictions on the number and type of shareholders.
- Self-Employed: An individual who owns and operates their own business, working for themselves rather than an employer. Self-employed individuals can be sole proprietors, independent contractors, or members of a partnership or LLC.
- Articles of Incorporation: Legal documents filed with the state to formally establish a corporation. These documents include the corporation’s name, purpose, structure, and other essential details.
- Operating Agreement: An internal document for LLCs that outlines the management structure, operating procedures, and ownership interests of the members.
- Partnership Agreement: A legal document that outlines the terms of a partnership, including the responsibilities, profit and loss distribution, and procedures for resolving disputes among partners.
- Bylaws: Rules and regulations adopted by a corporation’s board of directors after incorporation. Bylaws govern the corporation’s internal management and procedures.
- Shareholder: An individual or entity that owns shares in a corporation. Shareholders have ownership interests in the corporation and may have voting rights on major corporate decisions.
- Board of Directors: A group of individuals elected by shareholders to oversee the management of a corporation and make major decisions on its behalf.
- Dissolution: The process of legally dissolving a business entity, which involves settling debts, distributing remaining assets, and filing the necessary documents with the state.
- Liability: The legal responsibility for debts and obligations. Different business structures offer varying levels of personal liability protection for their owners.
- Fictitious Business Name (DBA – Doing Business As): A name that a business operates under that is different from its legal name. A DBA must be registered with the appropriate governmental agency.
- EIN (Employer Identification Number): A unique identification number assigned by the IRS to business entities for tax purposes. Also known as a Federal Tax Identification Number.
- Intellectual Property (IP): Creations of the mind, such as inventions, literary and artistic works, symbols, names, images, and designs used in commerce. IP rights provide legal protection for these creations.
- Trademark: A symbol, word, or words legally registered or established by use as representing a company or product.
- Patent: An exclusive right granted for an invention, which allows the patent holder to exclude others from making, using, or selling the invention for a specified period of time.
- Copyright: Legal protection granted to the creators of original works of authorship, such as literary, musical, and artistic works.
- Non-Disclosure Agreement (NDA): A legally binding contract that establishes a confidential relationship between parties and restricts the disclosure of confidential information.
- Franchise: A business model where a franchisor grants a franchisee the right to operate a business using the franchisor’s brand, products, and operational methods in exchange for a fee.
- Licensing Agreement: A legal contract in which one party (the licensor) grants another party (the licensee) the right to use intellectual property, such as a trademark, patent, or technology, under specific conditions.
- Mergers and Acquisitions (M&A): Transactions where one company merges with or acquires another company, combining operations and assets.
- Joint Venture: A business arrangement where two or more parties collaborate on a specific project or business activity, sharing resources, risks, and profits.
These terms cover a broad spectrum of concepts in business in general broadly goes from law to business structures to providing a foundational understanding for anyone involved in business operations.
These terms should provide you enough solid foundation for understanding the various financial and administrative aspects of operating a successful business. You’ll be knowledgably as a business owner with a master’s degree. Familiarity with these concepts will help in navigating business laws, contracts, evaluating financial obligations, and tax implications with understanding of the overall financial scope of knowledge that’s sometimes can only be felt through experience.
Real life experience with strong knowledge and foundation will have stronger impact to your business decision making than just going at it blindly.
Best of luck!
We wish you much success.
