Many years ago, the great John Paul Getty, who once held the title of the richest man in the world, made the statement “Lease What Depreciates – Buy What Appreciates” as a fundamental philosophy that prudent companies should follow. Most of us in the leasing industry keep the statement in our arsenal to convince companies to lease their equipment.
But what does it really mean? Let’s break the statement down into its two components and discuss why it makes perfect sense.
First, “Buy what you value” Put simply, it means owning assets that are increasing in value. Prudent businessmen generally live by the rule of increase, which refers to continued growth. Revenue growth, company size growth and net worth growth.
Very few assets that generate revenue and help grow a business appreciate in value. For example, a manufacturing facility that costs $100,000 today may be worth as little as $60,000 or $70,000 a year from now. The equipment can actually reduce costs by 20% and increase efficiency by 30%, but if purchased outright will actually decrease the company’s net worth over time.
Assets are depreciated at a preset rate of between 10% and 50% depending on which class they fall into. In year 1, the amount of depreciation falls under the 50% rule, which means that only half of the depreciation can be used as an expense. The net effect is very slow depreciation for tax purposes and erosion of the company’s net worth over time.
Secondly, “Leasing what loses value”, refers to the transfer of ownership of assets that depreciate in value over time to a third party, also known as a leasing company. From an accounting perspective, leased equipment is considered off-balance sheet financing, meaning it does not appear as a liability on the balance sheet. This accelerates the tax impact of a lease because if the lease is properly structured, the payments are treated as an expense and are 100% amortized from day 1. Off-balance sheet financing improves financial metrics such as debt from equity because the debt is not included on the balance sheet.
The business model of most leasing companies is designed to add multiple assets to the financial statements and thus focus on huge depreciation costs. Leasing companies thrive on adding assets to their books and, in turn, fills a great need for organizations that acquire assets.
One last note. Many companies have a strong tendency to own devices—a sense of ownership. It must be noted that when an equipment purchase is secured by a bank loan or line of credit, they do not actually own the equipment until final payment is made. Although you own the equipment and recognize the depreciated value as an asset, you do not own the equipment until the loan is paid in full.
Will companies buy equipment with a loan? Absolutely. Will companies use leasing as a means of acquiring equipment? Absolutely. The purpose of this article is to take a closer look at Mr. Getty’s statement many years ago “Lease What Depreciates – Buy What Appreciates” and to look at ways to acquire equipment from a different perspective.