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April 2001
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Financing Technology

Asking the Right Questions

By Tom O'Connor

TECHNOLOGY financing discussions generally revolve around the eternal debate: should I lease or buy? However, before you get to that dilemma, be sure you have answered critical preliminary questions. Your need a systematic method for acquiring computer equipment that is part of a focused and coordinated acquisition and development strategy.

Asking the Right Questions

Needs Assessment

Begin with a plan that includes a needs assessment, a budget, specific objectives and a time frame for implementation. Only as part of such a comprehensive plan should you undertake a cost analysis of hardware investment.

Do not forget trying to get a return on those expenditures. Identify specific costs and attempt to define ways for possible cost recapture. Don't ignore new billing options as a possible way to facilitate the process of capturing a return.

First, perform an inventory of your current equipment and decide what you need. Yes, that's need, not want. Don't get caught up in the fervor of buying the latest and greatest dual-quad, overhead cam, blazeware chip set because it looked great in that Super Bowl ad with the Stones howling about satisfaction in the background. Do you really need a 900 MHz Pentium III or will something less do the job equally well for you?

What should new computers do that your current computers can't? Handle new software? Access the Internet? Work outside the office? All of the above? Once you know what you need, you can ask the next questions: How many? How big? How fast? Who gets them? How long do you need them?

That last question may be the most important. If Moore's Law continues to hold true, and chips double in power every 18 months (some experts feel that the cycle is actually shrinking), what is the reasonable life cycle of your equipment? Even given that the fact that after a chip is developed it takes a while to get to market and be widely available enough to make the price reasonable, you're still facing a three year life for usability at the outside.

That doesn't take into account the relationship between software and hardware we mentioned above: Sometimes you need to upgrade hardware even when it's inside that three-year cycle because you need to use a new software that's been developed for a fast new chip set.

Next, set a budget. Drawing up a budget forces you to make decisions as to what is really necessary. The alternative, buying piecemeal without a budget, makes each individual purchase seem acceptable; only later will you realize how much you've overspent.

Once you have these figures, stay within the budget! Develop numbers to track all costs, including not just equipment but labor, supplies and overhead. Try to cost out the current state of the firm's operation, and analyze the costs of changes within a certain time line. Either all this can be done to satisfy an arbitrary budget number or to develop a reasonable such number.

Several different methods for developing cost figures have been developed over the years. They vary from a standard fixed cost method to an averaging costs method to innovative new strategies. Decide how much you will spend and stick to that figure. Too many firms become entangled in an endless cycle of purchasing upgrades for both hardware and software because they didn't follow this advice.

Remember, however, that the true cost of a computer is not just the purchase price of the equipment itself. Include a budget for training, support and maintenance. (Annual maintenance often runs 12 to 15 percent of the hardware costs.) The lifetime cost of maintaining the average computer is typically four or five times the cost of purchasing the computer.

Once you have your budget figures, set a time frame for implementation.

Leasing

So now you know what you want, how much you want to spend and how long you want to take to spend it. Now we can talk about leasing. Leasing has some obvious attraction: minimal cash outlay, fixed monthly payments, no reduction of credit lines, easy upgrading and you pay for assets as you use them.

That being said, traditional leasing methods aren't always the most advantageous. Not only are the prices not that good, but companies that offer incredibly low (often as low as $1) buyout leases run the risk of being re-classified as installment purchases by the IRS. The result could be not only penalties but the need to re-classify the transaction on your books as a capitalized/depreciated fixed asset purchase.

Use leasing companies that specialize in technology leasing and understand the best way to handle end of lease disposal of equipment. Companies that know how to resell such equipment have less need to make a high rate on the initial lease and can offer lower payments during the lease term. The bottom line is that if you lease you want to spend less than if you purchased the computers outright and you probably don't want to buy out the computers after three years because they will be obsolete.

Consider "layered" leasing: a combination of a lease for certain products and selective purchases for others. Computers become obsolete in a predictable time period. But other products, such as hubs, routers, printers or modems, may have a much longer life cycle.

Find an experienced leasing company that will structure a layered leasing approach where the lease will have a three year term on "three year products," a two year term on "two year products" and a five to seven year term on products with long shelf lives. It's like leasing a car: drive it for the lease term, turn it back in and get a new unit that you lease all over again.

This approach seems extremely practical, and offers a reasonable assurance that you won't have outdated products. As always, however, run this by your accountant to verify it meets all the current tax rules.

Tom O'Connor is director of education and training at Seattle's Pacific Legal. A member of the LTN Editorial Advisory Board, his is the author of The Automated Law Firm, from Aspen Law & Business.

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