Leasing

What is leasing?

Leasing denotes the transfer of an asset, such as a vehicle, a machine or a property, for use for an agreed period against payment. The word comes from the English to lease (to rent); tax law speaks of an economic asset (Wirtschaftsgut). The lessor acquires the asset and remains its legal owner, and the lessee uses it against ongoing lease instalments. Under civil law, the lease agreement is predominantly classified as a special form of rental contract.

Leasing is a widespread form of investment financing. The parties are the lessor, the lessee and usually a manufacturer or dealer from whom the lessor buys the asset after the lessee's selection. An assignment arrangement is customary: the lessor excludes its own warranty and in return assigns its claims against the supplier to the lessee. In company valuation and company acquisitions, leasing is one of the topics where the accounting treatment has a direct effect on metrics and purchase price. There is also private leasing, mainly for cars; questions of the balance sheet and trade tax concern only commercial leasing.

Types of lease: operating lease and finance lease

• Operating lease: short term in relation to the useful life or short-notice termination. The lessor bears the investment risk and the residual value risk, that is, the risk that the asset is worth less at the end than calculated. It often leases the asset out several times; economically the contract comes close to rental, often supplemented by maintenance and service.
• Finance lease (Finanzierungsleasing): fixed basic lease term during which the contract cannot be terminated by ordinary notice. The lessee bears the risk of loss, damage and loss of value; economically the contract resembles a financed purchase.

Within finance leasing, the leasing circulars (Leasingerlasse) distinguish two contract types. These are administrative instructions of the German Federal Ministry of Finance that govern to whom a leased asset is attributed for tax purposes. In full-payout contracts, the instalments during the basic lease term cover the lessor's entire costs including financing and profit. In partial-payout contracts, a calculated residual value remains open, which the lessor secures through a put option (Andienungsrecht), a share in surplus proceeds or a final payment on termination. With the put option, the lessor can require the lessee to buy the asset at the end at the agreed residual value, even if the market value is lower.

Leasing in the lessee's HGB balance sheet

Under Section 246(1) sentence 2 of the German Commercial Code (Handelsgesetzbuch, HGB), an asset is recognised by whoever it is economically attributable to. For lease agreements, practice follows the tax leasing circulars, distinguishing between movable and immovable assets and between full and partial payout. For full-payout contracts on movable assets, economic ownership generally lies with the lessor if two conditions are met. The basic lease term is between 40% and 90% of the customary useful life, that is, the period over which the asset is used according to the official depreciation tables. And the lessee has no option to buy the asset at the end, or to rent it further, on terms more favourable than the arithmetic residual value after straight-line depreciation (residual book value).

If the basic lease term is outside this range, or if the asset is so tailored to the lessee that only the lessee can use it sensibly (special leasing), it is attributed to the lessee. The lessee then takes it into its balance sheet at the acquisition cost on which the instalment calculation is based (capitalisation) and depreciates it over its useful life. On the liabilities side, it shows a liability to the lessor. It splits the instalments into an interest and cost component, which is an expense, and a repayment component. Because even a purchase option or a differing basic lease term can change the attribution, the draft contract belongs in a tax review before signing.

Lease agreements are mostly structured so that the asset is recognised on the lessor's balance sheet. The lessee then books the instalments as current expense; neither the asset nor the payment obligation appears in its balance sheet, the future instalments at most in the notes as other financial obligations. The same attribution applies for tax purposes. For trade tax, part of the lease instalments is added back to profit (Section 8 No. 1 letters d and e of the German Trade Tax Act, GewStG), to the extent that the sum of all add-back amounts exceeds an allowance.

For comparison: leases under IFRS 16

IFRS 16 has applied since 2019 and only to financial statements under the International Financial Reporting Standards (IFRS), which are applied mainly by capital-market-oriented groups and their subsidiaries. Besides leases in the narrower sense, the standard also covers rental and tenancy contracts, for example for office space, and no longer distinguishes between operating and finance leases for the lessee. In principle, every lease gives rise to a right-of-use asset on the assets side. On the liabilities side there is a lease liability in the amount of the present value of the future payments, that is, their value discounted to today. Contracts of up to twelve months and assets of low value are exempt at the lessee's option.

In the income statement, depreciation and interest expense take the place of the lease instalment. As a result, EBITDA (earnings before interest, taxes, depreciation and amortisation) and operating cash flow rise. The repayment component appears in cash flow from financing activities. Net debt rises by the lease liabilities, where these are included. In the first years of the contract the total expense is above the instalment, because the interest component is largest at the beginning. IFRS 16 does not apply to financial statements under the HGB; buyers and financial investors, however, often convert HGB figures to their own reporting logic.

Leasing in company acquisitions

In the bridge from enterprise value to equity value, the value of the shares, net debt is deducted. Whether lease obligations are part of it depends on how the EBITDA to which the multiple is applied was determined. The multiple is the factor of EBITDA with which buyer and seller determine the enterprise value. If EBITDA includes the instalments as an expense, as under HGB where the asset is attributed to the lessor, the obligations are not deducted in addition. If an EBITDA before lease expense is used, as IFRS 16 reports it, the lease liabilities belong in net debt.

Finance leases recognised by the lessee under HGB are treated like a loan in both cases. Purchase agreements and loan agreements therefore state expressly which lease obligations count as financial liabilities. In due diligence, buyers examine terms, residual value risks and the lessors' consent rights. Banks often count lease instalments towards debt service when assessing debt service capacity, that is, the ongoing payments of interest and repayment.

Worked example: leasing and IFRS 16 in company valuation

A company reports an EBITDA of EUR 6.0 million under HGB. This includes lease and rental instalments for vehicles, IT and office space of EUR 1.0 million per year as an expense; the contracts have five years to run. Financial liabilities are EUR 5.0 million, liquid funds EUR 2.0 million. Buyer and seller have agreed on eight times EBITDA under HGB.

• Lease liability under IFRS 16 at an assumed 5% interest: EUR 1.0 million × present value factor 4.33 for five annual payments = around EUR 4.33 million
• EBITDA before lease and rental expense: EUR 6.0 million plus EUR 1.0 million = EUR 7.0 million
• Net debt without leases: EUR 5.0 million minus EUR 2.0 million = EUR 3.0 million; with leases: EUR 3.0 million plus EUR 4.33 million = EUR 7.33 million
• Consistent calculation under HGB: 8 × EUR 6.0 million = EUR 48.0 million enterprise value; minus EUR 3.0 million = EUR 45.0 million equity value
• Consistent calculation under IFRS 16 with the same equity value: 45.0 plus 7.33 = EUR 52.33 million enterprise value; multiple 52.33 / 7.0 = around 7.5
• EBITDA before lease expense but without deduction of the lease liabilities: 8 × EUR 7.0 million minus EUR 3.0 million = EUR 53.0 million
• EBITDA under HGB and additional deduction of the lease liabilities: EUR 48.0 million minus EUR 7.33 million = EUR 40.67 million

The last two calculations mix the systems; between them lies EUR 12.33 million. A valuation on the basis of IFRS 16 is consistent only if the multiple comes from comparable values under IFRS 16 and the lease liabilities are deducted. Because EBITDA under IFRS 16 is higher, the appropriate multiple is lower, here around 7.5 instead of 8. At the same time the example shows the higher initial expense under IFRS 16. In the first year there is EUR 0.866 million of depreciation (EUR 4.33 million divided by five) and EUR 0.216 million of interest (5% of EUR 4.33 million). Together that is EUR 1.082 million, while the instalment is EUR 1.0 million.

Distinctions: leasing, hire purchase, loan and sale and lease back

• Sale and lease back: the company sells an asset it already owns to the lessor and rents it back. In classic leasing, by contrast, the lessor finances a new acquisition.
• Hire purchase (Mietkauf): ownership passes to the tenant with the last instalment. The asset is therefore recognised on the hire purchaser's balance sheet from the start.
• Investment loan: the company buys with a loan, becomes the owner, recognises asset and loan and generally provides collateral.
• Capex and opex: leasing shifts capital expenditure into current expenses, as long as the asset is recognised on the lessor's balance sheet under HGB.

Common mistakes

• Only the instalment compared. Only the total cost including special payment, ancillary costs and residual value arrangement is meaningful, compared with the purchase price and financing costs of a loan.
• Put option overlooked. In partial-payout contracts the lessor can require purchase at the calculated residual value, even if the asset is worth less.
• Leasing presented as deleveraging. Banks, investors and buyers regularly include lease obligations when assessing the debt ratio.
• Inconsistent purchase price bridge. Anyone who determines EBITDA and net debt under different systems shifts the equity value for no substantive reason.
• Return conditions not priced in. Usage limits, condition requirements and excess mileage are settled separately at the end of the contract.
• Consent rights overlooked. In an asset deal, lessors must consent to the assignment of the contract; in a share deal, change-of-control clauses can trigger termination rights.

Frequently asked questions

Is leasing cheaper than a purchase on credit?

In total payments usually not, because the lessor prices in its financing costs, its residual value risk and its profit. The benefit lies in preserved liquidity, a lower need for collateral and, where applicable, service benefits.

What is the lease factor?

The lease factor shows what percentage of the list price the monthly instalment amounts to. It serves mainly in car leasing for a quick comparison of offers: the lower it is, the cheaper the instalment.

Formula: Lease factor = monthly lease instalment divided by list price × 100

A special payment, that is, a down payment at the start of the contract, lowers the instalment and the factor without making the leasing cheaper. For a fair comparison it is therefore spread over the term and added to the instalment (total cost factor).

Do lease liabilities count as financial debt in a company acquisition?

That depends on the definition of the EBITDA to which the multiple is applied. Finance leases recognised by the lessee, by contrast, are as a rule deducted like a loan.

Can young companies lease?

Yes, although the lessor checks creditworthiness like a lender. With a short company history, lessors often require a special payment, a deposit or a guarantee from the shareholders.

What happens at the end of the contract term?

The contract governs this: return, purchase at the agreed price, extension or, in partial payout, put option exercised by the lessor. The arrangement belongs in the cost calculation before signing.

The Roemer Capital view

In financial models that Roemer Capital builds as fractional CFO or to prepare a funding round, lease and rental obligations are carried with term, instalment and residual value as separate cash flows. This makes visible how the burden develops when contracts expire or the company grows. At the same time, the planning can be reconciled with the HGB financial statements and with the IFRS metrics of a later buyer.

In a company sale, Roemer Capital determines early on which basis EBITDA and net debt are defined on, and maintains this definition from the teaser to the purchase agreement. If the basis changes during the negotiation, the equity value shifts without anything having changed in the company.