The Green Sheet Online Edition
March 09, 2015 • Issue 15:03:01
Leasing 2.0 – An old tradition gets a new look
Some payment professionals see a bright future for credit card terminal leasing; others believe it's an outdated practice. Leasing executives say their products are evolving in response to payments industry trends. While debates rage on, a large number of rank-and-file agents are writing leases every day.
How has leasing changed in recent years, and why does it remain a popular choice of merchant financing? Following are industry stakeholders' opinions on leasing past, present and future.
The best of times, the worst of times
An old adage states, "If you can't be a good example, then you'll just have to be a terrible warning." The leasing industry has seen its share of terrible warnings from unscrupulous merchant level salespeople (MLSs) who have earned upfront commissions for fraudulent or excessively overpriced leases. Many of these agents have been permanently barred from selling merchant services.
Another common, but controversial practice is to offer free or low-margin processing accounts to merchants in exchange for a 48-month lease. In such cases, merchants can pay as much as $130 dollars per month for a countertop terminal, with minimal transaction fees and pass-through interchange pricing.
These free processing deals are a clever rebuttal to free terminal programs but generally benefit MLSs more than merchants, who are frequently held hostage to 48-month terms and are unable to change equipment or processors unless they're willing to buy out the remaining balance on leases they cannot cancel. In some cases, the balance owed on a small piece of equipment is enough to finance an integrated POS system.
John Beebe, President and Chief Executive Officer at Celestial Payments and Chief Operations Officer at Small Business Funding, has seen a steady decline in leasing margins as the payments industry has matured. He described the early days of leasing as "explosive," compared with the current environment in which leases are just another financing option.
"Back in the day, agents could take a $200 to $300 terminal and net out $1,100 to $3,000 on one piece of equipment using a 48-month lease at $28 a month, depending on a merchant's credit," Beebe said. "I don't believe we'll see that kind of profit margin in leasing again."
Lease or buy: MLSs debate merchant options
Ken Musante, President of Eureka Payments LLC, and former Street SmartsSM columnist, penned a two-part article titled "Will leasing make a comeback?" and published in The Green Sheet on Jan. 10 and 24, 2011, in issues 11:01:01 and 11:01:02, respectively. The article shared discussion threads from GS Online's MLS Forum on the future of leasing.
Many of the article's positions on the relative merits of leasing versus buying remain equally relevant today. The sidebar accompanying this article contains a post from Forum member BER about why leasing a terminal can be more advantageous to a merchant than buying, from both a cash flow and depreciation perspective.
Leasing industry gets tough on fraud
Four years after his two-part article appeared in Street SmartsSM, Musante noted that predatory and fraudulent leases still exist but are not as prevalent. "You're less apt to see someone get soaked, but it still happens," he told The Green Sheet.
Barclay Square Leasing Inc. implemented strict policies to screen out fraudulent paperwork. Wendy Zucker, National Sales Director and Owner of the company, acknowledged that Barclay requires MLSs to include a merchant processing application and Merchant Identification Number with lease applications for validation purposes. She's encouraged that other leasing companies have adopted similar measures to protect merchants and ISOs from unfair pricing and fraud.
"I usually ask [new] agents how many leases they write in an average month; 89 is not a good answer. If they write an average of 100 apps a month and maybe 12 or 13 of them are leases, then that's a better ratio."
Zucker and her team avoid working with self-serving MLSs who value upfront leasing commissions more than residual processing revenue that accumulates over time. "I want to work with agents who are in it for the long haul, who respect merchants and want to protect them [by offering] up-to-date, EMV-ready and PCI-compliant hardware and software," she said.
Zucker sees a silver lining in leasing's compression and smaller margins, believing that these trends will help weed out predators and attract more "quality people" into the space. She gave an example of a merchant with average credit, paying $79 a month on a four-year lease, amounting to $4,100 dollars for a credit card device that might cost $400 dollars.
"The rep makes $2,100 to $2,500 gross profit on a $300 to $400 piece of equipment, before equipment is paid in full," Zucker said. "I'd rather write a reasonable lease and have happy clients." She further described leasing as a "long game" and said she appreciates working with MLSs who have long-term goals and place more value on quality than quantity.
"Every deal has to stand on its own merit," Zucker said. "I need to be very clear – one phony deal and I'm done."
Leasing's new role in expanding finance universe
Leasing was once the only way for merchants to finance terminals; today it shares the stage with an array of finance options. Industry analysts expect traditional and hybrid leasing products to join a broadening mix of nonbank finance solutions.
Richard J. Hahn, Vice President of Sales at New York-based Northern Leasing Systems, said leasing is on the rise, with 25,000 leases, on average, written per month in the United States. He cited the following three reasons for this:
- Changing payments technology: EMV migration, Payment Card Industry Data Security Standard guidelines, and mobile payments are driving adoption of newer technology and devices.
- Small POS systems: Popular tablet POS systems are typically priced at around $2,000, a "perfect price for a lease."
- Margin compression: Shrinking residuals can push MLSs into leasing. With residual volumes below $50 per merchant, "one cannot afford to stay in this business," Hahn said, adding that it discourages people from even entering the space.
Musante expects leasing to flourish along with other forms of alternative lending, which became popular during the Great Recession when many people were unable to secure traditional financing. "Leasing is alive and well, and larger-ticket items are driving new business," he said. "Some of the more expensive POS systems are being bundled into other services."
Beebe said that leasing has been impacted by free terminal and micro-merchant programs that enable merchants to accept payments without having to buy or lease equipment.
"With free terminal offerings and the shift towards mobile and bring-your-own-devices (BYOD), there's not the same need," Beebe said. "In some respects leasing will make a comeback but it won't have the same profitability."
He expects saturation in merchant cash advance (MCA) to push more merchants into leases, especially for smaller-ticket items. "As they become over-extended, merchants that have two, three and four positions [simultaneous MCAs] and need equipment can save around $100 a month as opposed to having three to four cash advance companies tap their account every day," he said.
Finance leaders say a lease is not a loan
Many MCA ISOs consider leasing to be an off-the-shelf solution that is a poor substitute for tailored, individualized programs based on customer requirements.
Sean Murray, CEO of Raharney Capital LLC, a New York-based MCA consultancy, is encouraged by growing public acceptance of nonbank finance. He stressed the need to educate agents and merchants on how to use lending products efficiently. He has seen many liberal interpretations and innovative uses of alternative lending solutions, a trend he described as "a good and bad thing."
"It's good because merchants have the flexibility to use loan proceeds as they see fit," Murray said. "It's bad because it might be an indicator that they're applying the wrong solutions to their problems." He added that when a merchant chooses a five-year loan for a short-term need like an inventory purchase, or an MCA to refinance debt, he or she may be missing out on solutions that are a better business fit.
"The most important question is, what is the merchant trying to accomplish?" Murray said. "It may very well be that a lease is the best fit, but if not or if they don't qualify for one, then it's crucial to propose alternatives that make sense for the circumstances, not just ones that are easy to obtain."
Tailored finance products outrank one-size-fits-all
Zachary Ramirez, Director of Strategic Partnerships at Core Business Loans in Newport Beach, Calif., sees leasing as a patch or one-size-fits-all approach that isn't always in a merchant's best interest. Thus, he views leasing more as a tool for attracting short-term clients than as something conducive to customer longevity.
Ramirez believes leasing is not as advantageous as renting, buying or financing options that help clients secure funds without disrupting day-to-day cash flow. "Equipment leasing is an older form of doing business," he said. Options he prefers include selling equipment that merchants can keep even if they switch processors, and providing free terminals that merchants can return at any time for any reason.
"If you're looking to build long-term, sustainable relationships, then I'd suggest that agents offer products and services that reflect the needs and best interests of their clients," he added.
Chad Otar, Managing Partner at New York-based Excel Capital Management, also sees little sense in offering leases to clients who may be better served by other, more targeted finance products. Some of these products share common attributes with leases but they're generally more customized.
"In the world of cash advances we need to get in and out fast so we can get the funding for the merchant," Otar said. He endorses free terminal programs for MCA clients willing to switch their credit card processing accounts. He said free terminal programs are similar to leases because merchants pay back funds via an automatic credit card residual split or a lock box withholding arrangement.
Otar has seen free terminal and POS programs largely replace leasing in merchant services, and he doesn't envision a place for leasing in the new hyper-competitive payments ecosystem.
Murray recommends a client-centric approach to selling any kind of financial product. "Know your merchant," he said. "What is their credit history like? Do they have collateral? How long have they been in business? What is their average monthly sales volume?"
Free terminals for all
Harbortouch, a payments processor based in Allentown, Pa., rolled out a free terminal program to its MLSs in 2004 when the company was doing business under the name United Bank Card Inc. The program's success led to many imitations and free equipment programs throughout the payments industry. Years later, the company added a free POS system program to its offerings.
Hahn said the free terminal model, now an industry norm, initially drew criticism because it cut into MLSs' income. "Northern Leasing Systems had to adjust to this new reality by venturing into new markets such as Canada, Puerto Rico and the U.K.," he added.
Nate Hirshberg, Harbortouch Marketing Director, said the company still offers a leasing option for stand-alone terminals, but not for its signature Harbortouch POS systems.
Hirshberg feels the company's free equipment program has a better value and more sustainable business model for merchants than equipment leasing. He said the only reason Harbortouch continues to offer leasing programs is to satisfy requests from some of its agents who still prefer this method of selling.
"It is really up to the sales agent which option they want to present to the merchant: free placement or sales/lease," Hirshberg said. "However, the overwhelming majority of deals we receive are on our free equipment program. There are very few sales agents who continue to lease terminals, given the considerable benefits we offer through our free equipment program."
Freedom of choice
Fenella Kim, Founder and CEO of New York-based Reliance Star Payment Services Inc., acknowledged that free terminal programs have impacted terminal leasing, but sees a growing number of leases for higher ticket items.
"Many of our merchants lease ATMs and Clover POS systems," Kim said, noting that processing equipment is just a small part of a merchant's overall investment in infrastructure, inventory and other expenses related to setting up a new location or business.
"In addition to improving cash flow, many merchants appreciate the tax advantages of leasing," Kim noted. "POS systems are like computers, subject to wear-and-tear over time, and changing trends in payments processing. When their leases mature in 36 to 48 months, that's normally the time when merchants review their product mix and consider upgrading their point-of-sale equipment."
Leasing gets a new lease
Despite changing trends in payment card processing, leasing remains popular among merchants. Free terminal programs and declining equipment costs have significantly reduced leasing's margins and market share. But leasing, like cash and checks, remains stubbornly embedded in payments industry culture.
Perhaps what's most remarkable about the evolving payments ecosystem is its diversity of choice in products and services. MLSs, with the right resources and knowledge, can help merchants choose wisely.
Sean Murray acknowledged that sometimes the best solutions are ones that earn MLSs very little in commission. "That can be a tough pill to swallow," he said. "But if you make the customer happy, that can lead to referrals or additional business with them later on."
SIDE NOTE:Why Lease?
This information on buying versus leasing terminals was posted by forum member BER in the "Street Smarts Article - Will Leasing Make a Comeback?" thread on GS Online's MLS Forum.
Example 1: Merchant buys terminal for $350
- Merchant now has $350 less cash for business expenses, inventory, labor, expansion.
- Let's assume the useful life of the terminal is 5 years.
- At a salvage value of zero (meaning the terminal is useless at the end of 5 years and carries no value) the merchant can write off $70/year ($350/5 years, using straight line depreciation).
- At a salvage value of $50, the merchant can write off $60/year for 5 years ($350-$50/5 years).
- If the merchant waits 5 years to replace terminal, they can take full advantage of the depreciation.
- If merchant replaces before 5 years, merchant does not take full advantage of depreciation.
Example 2: Merchant leases terminal for $13/mo for 36 months
(I came to $13/mo by assuming that the terminal in the above example has a cost of $250 and a profit of $100, then figuring a funding rate of 75 percent of total payments. So working backwards ... $350/.75 = $466.66 for the total payment to get $100 in profit; then divide the total payments by 36 months, the term of lease; $466.66/36 = $12.96, rounded to $13.)
- Merchant can write off the total of the lease payments each year, or $156/year each year for all three years ($13 x 12 mos).
- Each year, the merchant writes off their exact cost of the lease that year, what they actually spent, no waiting for the depreciation to equal their initial expense on the terminal.
So why would a merchant lease?
- One of my business professors always said, 'If you can use someone else's money, do it' ... in regards to the cost of your own capital. The same applies here in the lease situation. Like I stated before, if a merchant spends an initial investment of $350, he will have less money for business expenses, expansion, materials and labor.
- The math works out the same, after tax deductions, for a lease versus an outright purchase:
+ $350 written off in 5 years, if you assume $0 salvage ($70/yr)
+ $468 written off in 3 years if leasing ($156/yr)
- The benefit here is that a merchant can get a new terminal every three years with the same after tax cost.
- Also, some leases cover if the terminal gets broken, defective, etc. That is a direct advantage of purchasing.
When a merchant spends on a lease, they write off the same amount they spent that year, as opposed to depreciating the terminal over 5 years in the situation of a purchase, where a merchant would spend $350 the first year and write off $70.
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