It is a common practice for a leasing company to offer lessees the option to purchase software or equipment at the end of the lease term at its fair market value. Generally, the advantage to a lessee of having a fair market value purchase option is that monthly lease payments are lower and potentially the lease can be classified as an operating lease for accounting purposes. Lower payments result because the lessor, in calculating the lease payment, factors in its best judgment of what the fair market value will be.
From the lessee's standpoint, however, there can be a significant risk in any lease with an uncapped fair market value. An uncapped fair market value option means that if the lessee desires to purchase the software or equipment at the end of the lease, the option price is the fair market value which bears no relation to what has been paid over the course of the lease. If the lessee intends to purchase at the end of the term, capping the fair market value will limit the risk of making a large payment at the end of the lease. In addition, a capped fair market value reduces any potential animosity between the lessor and lessee as both parties know the maximum the lessee will required to pay.
If software is collateral, the problem of an uncapped fair market value is even more acute. General software industry practice is that maintenance is paid by the lessee on an annual basis. Maintenance normally provides the lessee with software upgrades. Thus, the fair market value of software at the end of the lease may well be close to its original cost.
In short, it is best to have a capped fair market value from the lessee's perspective to insure that both lessee and lessor are aware of the maximum amount the lessee will be required to pay over the term of the lease.
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February 27, 2006