What is a lease option?

A lease option is a time and cost-saving option used by information technology (IT) companies that cannot afford large investments. By choosing to lease Software, a firm does not get its ownership directly. Instead, the firm has to pay a fixed cost for a certain period to use the Software, and after the lease period, the company can purchase the Software.

Most small and large IT firms opt for leasing software since it cuts down the time and cost to develop the application and requires less human resources.

Lease agreement

A lease agreement is a legal contract made between the renter and tenant-buyer before entering a lease option. The contract specifies the conditions under which the tenant-buyer agrees to rent the software from a renter. In brief, the financial conditions and other binding conditions are documented in a lease-option agreement.

Factors to consider while choosing a lease option

Before entering a lease option, IT firms should consider the following factors:

• Suitability- Companies should check whether the Software or application fulfills all the business requirements. Companies also need to determine if the Software will accomplish its tasks as needed.
• Scalability- As a business progresses, the Software should be updated to fulfill the increasing demands. Businesses need to lease Software that can meet the growing demands of clients. Generally, custom software is leased so that it can be modified to meet future needs.
• Flexibility- Different clients have different requirements. The leased Software should be flexible enough to meet all the client requirements.
• Support- Technology can fail anytime. Most companies provide telephone, email, or in-person support when the leased Software corrupts. IT firms should lease Software from companies that have an excellent support team.
• Interoperability- The leased Software should be able to communicate with other applications.
• Ownership- Generally, leased Software has a base code and customization code. The customization code is written to make the Software perfect for a particular company. As per the lease contract, the owner of the base code is the dealer, whereas the buying company holds the rights (license) to use the Software for the defined period.
• Cost of Software- Usually, companies ask the purchaser to pay a certain amount of fees every month, as the lease cost to use the Software. Apart from this, the buyer also needs to pay extra costs like maintenance and support fees. Hence, the total cost of the Software may depend on the owner’s pricing terms.

Requirements of a lease option

Since the lessor gives the lessee software to use for a certain amount of period, the lessee needs to meet certain requirements to be eligible for using the software. Some of the requirements of a lease option include:

• Completing the lease application and getting it approved by the dealer.
• Paying rental charges comparable to the current local market prices.
• A lessee should have a good credit score.
• Lessee will have to prove that he is capable of paying the lease option price.

Working of a lease option

When a company chooses to lease Software, the company has to sign a lease contract or agreement with the dealer/ vendor. The cost that the company has to pay for using the Software has to be decided in advance and should be mentioned in the contract. The lease cost varies from company to company.

The lease period may last for any amount of time. It is three, five, seven, or ten years in most cases.

The company can use the Software until the lease period is over. The contract will have clauses regarding what will happen if the company breaks the contract or terminates it before the lease period ends. After the lease period ends, the company gets the option to buy the Software.

Advantages of lease option

There are various advantages of opting for a lease option deal. These include:

• The company does not have to use the same Software for years by leasing software. The company can lease the latest Software running in the market after the lease period is over.
• Businesses that cannot afford to pay a large amount of money up-front can use Software by paying the down payment only.
• Companies can predict the monthly expense of the Software because the lease payments of the Software will be determined at the beginning of the contract.
• Leased Software requires less IT staff since the company has to manage the Software and not develop it from scratch.
• Customized leased Software fulfills most of the business requirements.

Disadvantages of lease option

Though leasing has several benefits, there are a few downsides of using such Software:

• Some dealers do not offer support and maintenance of the Software.
• Some software has limited customization options.
• When buying Software, the company has to pay a one-time cost, but in the case of leasing, companies need to pay interest for using the Software every month.
• Even if the company stops using the Software, it will have to pay for it until the lease period gets over.

Benefits of buying vs leasing

Most companies find leasing a great option. However, some find buying Software more beneficial due to the following reasons:

• Buying software needs no paperwork or minimum paperwork.
• The lease terms need to be negotiated and can get complicated sometimes.
• In the case of leasing, the company will have to maintain the Software as mentioned by the dealer. However, when the company buys the Software, the buyer does not have to worry about the maintenance.
• The purchasing company can deduct the purchase price for the equipment and save itself from paying tax in the initial year. However, the company can only deduct the monthly payment in the lease option.

Context and Applications

The lease option is a concept of an information system. The topic is covered in various undergraduate and postgraduate courses like:

• Bachelor of Science in Information Technology
• Master of Science in Information Technology
• Bachelor of Science in Computer Science
• Master of Science in Computer Science

Practice Problems

Q1. Why do IT firms choose the lease option?

1. To save time and money
2. For fair market value entertainment
3. To save travel rent payments
4. To destroy the subject property

Answer: Option a

Explanation: The lease option saves the time and money of IT firms since the firms do not have to invest time and money in developing the Software from scratch.

Q2. For how many years does the lease period last?

1. Five
2. Ten
3. Three
4. Any number of years

Answer: Option d

Explanation: The lease period can last for any number of years.

Q3. Under which of the following circumstances does a company find it beneficial to lease Software?

1. When the Software is hard-to-sell
2. When the company does not have enough money
3. When the Software is damaged
4. When the company is in rent credit debt

Answer: Option b

Explanation: The lease option proves to be beneficial when a company does not have sufficient funds but needs software. This option lets the company use the software by paying the upfront fees and monthly lease costs.

Q4. Which type of contract do the dealer and buyer need to sign to enter a lease?

1. Lease agreement
2. Agreed-upon purchase price agreement
3. Rental agreement
4. Rent-to-own agreement

Answer: Option a

Explanation: The IT company (buyer) needs to sign a lease contract with the dealer to enter a lease option.

Q5. Which of the following is an advantage of the lease option?

1. It is expensive
2. It consumes a lot of time
3. It requires less IT staff
4. It competes with real estate investors

Answer: Option c

Explanation: One of the advantages of choosing the lease option is that the IT firm does not require a lot of IT staff to maintain the leased Software.

Common Mistakes

The terms lease option and buying have minor differences. Hence, students often use these terms interchangeably, which is not correct. They are different terms, so students should understand their difference clearly and not mix them up.

Related Concepts

• Buying software
• Developing Software
• Financing options for Software
• Option-to-purchase
• Lease-to-own