SOFTWARE LEASING - SALES TOOL AND FINANCING OPTION

The following are excerpts from a presentation given by Mark S. Bazrod at THE CULPEPPER FORUM - ďGOING FOR THE SOFTWARE GOLDĒ in Atlanta, GA on July 9-11, 1996. The session was highly interactive so it contains numerous questions from the audience, which should make the presentation more useful for you. The full version of the presentation is about 7,100 words (21 pages) and we have condensed it to about 3,800 words. If you would like a copy of the full version of the presentation, including the slides, please contact Mark Bazrod at msb@lpilease.com or his direct phone number, 610-341-6100, or write to LPI Software Funding Group, Inc.

Leasing is now an accepted part of corporate America. So lots of companies lease and the strange thing is that most software companies and most software users are not aware that you can lease software. It is in part because leasing companies and banks traditionally have said they will lease hardware, but software has no value, it is a ďsoftĒ cost. There are now a dozen leasing companies who will do a 100% software lease. I think everyone here at the Culpepper Forum will be leasing software in a couple of years; in fact, you better be leasing software because many of your competitors are going to be offering leasing.

I am going to give you some indication as to what leasing is, why you ought to use it, the importance and use of budgets in large companies since a lot of you deal with many of them, and how you can use leasing.

Slide 3 is a list of some of the companies which offer software leasing. A number of them you probably know: Astea, Boole & Babbage, Computer Associates, IBM, Oracle, Sybase, SAP, Shared Medical. Where there is an asterisk, we have leased the companyís software or we have agreements with them. Some of those companies do not even know that weíve leased their software because weíve made arrangements with the lessee and we didnít have to sign up the software company.

What we think makes the most sense for most companies is that they partner with a leasing company, at least in the beginning until they get the feel of the business. After a while you may say, ďWell, I think I understand leasing, I know what systems I have to get, and what sort of expertise I have to getĒ. At that point you decide whether or not you are going to do it yourself. It is really a form of outsourcing until you become familiar with leasing.

Question: How do you work with a software company?
With some of the companies, their sales reps call us and ask, ďIs this credit okay, can we do a 1 year lease, a 3 year lease, or a 5 year leaseĒ, and they discuss the transaction with us. We give them a credit approval and we will do all the documentation and then we pay the software company. The software company can be as involved or not involved as it desires. The sales reps at some companies quote lease rates and we donít even know it because we have given them ball park rates and if it looks like the deal is going to get done, then they will call us. There are others who call us even before they see the customer. We talk to some companiesí customers, and there are other software companies that they would rather talk to the customers themselves. It really depends upon what you feel comfortable with. Some people say they donít trust leasing salesmen and will not let anybody talk to the customer until they feel comfortable. You canít argue against that. Itís psychological. Itís whatever feels right for you. Itís the way you want to do business.

There are a couple ways to do software leasing. I prefer a lease because I think itís best from a marketing standpoint and it is simplest. The vendor gives the license directly to the customers so the leasing company doesnít get in the middle of marketing. You can do your selling in the normal way. We will sign the lease with the customer. That lease says that we pay the software company 100% of whatever the customer is supposed to pay and the customer pays us over time. At the end, the customer owns the license outright. During the time that the lease is in effect, we do have a lien on that software and we have a right, if the customer doesnít pay, to require the customer to stop using the software and return the software. Maybe we can do something with it or not, but basically the customer has to understand that. Thatís no different from any other financing. If you borrow or lease something and you donít pay, the bank or the leasing company has the right to take it away.

Question: Is the lease without recourse to the vendor?
It normally is without recourse, although we have done one transaction where the credit was so hairy that the vendor gave us a 50% guarantee. It was the only way that the transaction could have been done. Normally, there is no recourse to the vendor, at least the way we do software leasing.

What really is software leasing? Itís a sales tool as far as you are concerned. It is a way to speed up the sale, and thatís all it is. It does give the customer a way to get your software without paying cash upfront and for the CFOís in the room, it does reduce your DSO or days sales outstanding because if you had to give extended payment terms, your receivables on your balance sheet are going to balloon. Most analysts tend to pay a lot of attention, and maybe too much attention to the DSO. Instead of financing your customer, let the leasing company do it. As far as the user is concerned, itís just like an equipment lease, the only difference is itís for an intangible. Itís just like a loan.

Many companies lease. 65% of the Fortune 500 do. Itís accepted. 29% of computer equipment is leased. Why is only a couple percent of software leased? It doesnít really make sense, except that itís new and thatís why the Gartner Group thinks 25% of software will be leased by the year 2000. I think itís going to be higher than that if you look at business software. If leasing satisfies the customerís needs, then software leasing will also satisfy those same needs.

Now that you know what software leasing is, the question is why should you bother with it? I think there are real reasons that you ought to do it. One is it can increase your total sales and your average sale. It is a time machine for you. If it speeds up the sale, that makes you more effective during your window of opportunity that you have to move that software. In terms of Chasm Theory, it will get you to chasm faster, it will move you across the chasm faster, and you can get into the bowling alley. You will be able to knock down pins left and right and get a lot of momentum going. Two, software leasing also satisfies customersí needs. Large companies need your software and they often have a budgetary problem. Leasing can speed up the time that they can get your software. They can get to market faster or they can do whatever they need to do more quickly. Time is money so it has real value to the customers. Leasing will improve your competitive position. If you happen to be competing against someone who doesnít offer leasing or financing, then you have the competitive advantage. If your competing against someone who is offering leasing, and you are not, youíre at a disadvantage. You can neutralize that disadvantage if you also offer leasing. Leasing is a great product. Assume you are going up against Computer Associates which offers leasing from day one when they go and talk to the customer. They are pushing leasing for a number of reasons; you ought to be able to do the same thing.

Question: What are their reasons?
The reason that Computer Associates offers leasing is, they say, it gives them one stop shopping. They can handle everything for the customer, the sale is not delayed because now that the operating guys like the software, they donít have to go over to the finance guys and request funding or approval. Itís all done in one shot. You also reduce the risk of the customer going to a competitor. You can get your sale done right away.

I want to take a couple minutes on the theory of budgets. I could ask the question, ďHave you ever had the sale delayed while someone waited for budget approval?Ē In many companies, there are two kinds of budgets - operating budgets for the current expenses and capital budgets for long lived assets. Next are the financial statements. In general, capital leases are leases where you can buy the equipment in the end for $1. An operating lease is basically a lease which has a fair market value option. In the theoretical world, there is a high degree of symmetry between budgeting and financial statements. However, when you get into the real world of large companies, what happens in most cases is if the thing is called a lease at the top of the paper, then people will put it in the operating budget if they have room in their operating budget and not in their capital budget. In fact, Iíve heard of cases where people donít have room in an operating budget, but they do have room in the capital budget so they will put an operating lease in the capital budget. Thatís the world of budgets and large companies. Large companies live by budgets, by and large. In 80% of the large companies that Iíve dealt with, the question is ďIf I can get this into an operating budget, Iíll get it and I really donít care what kind of lease it isĒ.

Question: Do operating people know this?
The guys at the operating level know that inside out. We arranged the lease of about $750,000 of software to a subsidiary of a large automobile company. What they wanted was 4 payments for about $200,000 a quarter because the president could sign checks for up to $250,000, and thatís why they did it.

Question: How did the lessee treat the payments for accounting purposes?
It was expensed. The interesting thing I think is not so much the software issue, but the question of training, installation, customization or whatever. In a lot of companies the accounting rules are that you must expense that stuff. That is insanity. Such items have as much usefulness as the shrink-wrap portion of the software. From your standpoint, you really want people to get as much training as they possibly can because it will make your software more effective. You donít want people not to get everything that they need. We are happy to put all that into a lease. You could just as well bundle all of your training into the license price. The fact that you unbundle it shouldnít make any difference. It doesnít make any difference to us because I think the value is the same.

Question: How much training and customization will you allow in a lease?
Whatever the customer wants to put in and we will talk to them about putting in more or not. However, if the customerís credit is somewhat shaky, we may not want that in there. Not because it really doesnít have value, but because we may not want that much exposure to that company. In fact, I would include the data conversion cost or conversion cost because what is the difference whether you do it as custom programming or the user does it internally. It doesnít matter.

Let me now get into the meat and potatoes of the talk. I told you leasing can shorten the sales cycle, but letís see if I can really back it up. One of the things that you can do is use leasing as a qualifier. You can bring up the points, such as, ďWhat is the procurement process or do you need capital budget approval?Ē When you start to ask those questions and try to find out what the needs of your customers are, you start to differentiate yourself from your competitors. Hereís some questions for you: ďIs this purchase within the budget; who approves the budget; is this going to be capitalized or expensed; are you aware that you can lease our software?Ē Most customers are not. I donít have any idea of what the percentage is, but many people donít know that software can be leased. Leasing is normally faster, simpler, and less restrictive than bank financing. Leasing companies and leasing people tend to be more entrepreneurial so they will tend to work around whatever problems there are. I think itís the breed gets attracted to the industry.

Not only can it shorten the sales cycle, but I think it can really increase your sale. Weíve seen a number of cases where people have said they need 100 seats, but only have room in the budget for 50 and they end up getting 50. Well, if you can offer leasing, since the initial payments are reduced, your customers can end up getting all the seats that they need and you can get higher sales.

You can offer a site license. You can put all sorts of costs in the lease and make it easier for the customer. We have one customer who sells multi-year maintenance because then they donít have to call back at the end of year 1, 2, 3, 4 and start tracking the customer and billing them annually. You do everything on day 1.

Leasing is a strategic marketing tool. For hardware companies and software companies, quarter-end and year-end discounts are the bane of your existence. Leasing may be one way to avoid discounts because you can offer leasing rather than 10%, 20%, 30%, or 40% discounts. Thereís a couple things that we have that we will get into in a minute. When you can give a customer a low interest rate lease, it looks like you are giving them a discount. You are! But itís not going to be a discount that 6 months from now someone is going to come at you and say, ďYou sold it for 25% off last time, I want 25% off this timeĒ. You may use leasing when you introduce a new product, and if you have a problem with sticker shock, it may help you. I donít really think it should. People have to recognize that if they are going to pay $100,000, they are going to pay lease payments that are going to be more than $100,000, but many people say that the elimination of sticker shock is effective.

I think the key is better satisfying your customersí needs with lease options. All your customers have different needs and we must have different types of leases to satisfy different needs.

We have milestone payment leases, real operating leases, low interest rate leases, and flexible payment terms. These really can assist your customer. What you want is a leasing company which is going to work with you to meet your customer needs. Slide 16 is an example of a milestone payment lease.

Question: If the customer doesnít pay, do you go back against the software company?
The short answer is no. The long answer is the customer always owns the license. We have a security interest in the license. If the customer doesnít make the last two payments, then we have a right under our lease to require the customer to stop using the software and return the software to us. What we can do with the software depends upon the license. But we do not go back against the software company.

Question: How long does credit approval take?
Normally it takes 2 hours or less. It depends upon the credit of the customer and the information available. If youíre talking about investment grade, they are no-brainers, but if you are talking about a middle market company, we will still do it in two hours. We may say itís okay probably based upon a D&B report. D&B doesnít always have good or recent financials, and if the amount is large enough, we are going to say that approval is subject to receipt of financials, but we donít anticipate that thereís going to be any problems because we may have some information from the D&B or other sources.

We have done several transactions where there were no financials at all for large amounts and for large companies and we didnít do those in 2 hours. We had to obtain a lot of information about the user from proprietary databases and the Internet and got satisfied. If we have a written agreement with the software company, weíll commit to a 2 hour turn-around.

Continuing on, if there is someone who wants a real FASB 13 operating lease, then there is a way for us to do it. Another way to use leasing is similar to what happens in automobile leasing where the vendor buys down the interest rate.

Your question is does this make sense for you. What benefit are you going to get from it. I think you got a great potential here because itís not going to lock you into that quarter-end discounting situation.

Next is an example of what happens when you vary the payment frequency from annual to semi-annual to quarterly or monthly. This is on 3 year lease for $100,000 of software. On an annual basis, 3 payments of $37,000; on a monthly, itís 36 payments of $3,289. The greater the frequency of the payment, the less the payment is going to be. You can also see something like this if you went from a 1 to a 2 or 3 year or a 5 year lease. The longer the lease term, the less the monthly payment is going to be. We can match lease payments to meet customer requirements. All lease payments donít have to be equal. We can make the beginning payment less because the customer doesnít have a lot of money in his budget or the beginning payments higher because the customer has a lot of money in this yearís budget, but doesnít have a lot of money in next yearís budget. Thus, we make the payments for the rest of this year high and make the later payments low. Leasing companies can normally vary the payments any sort of which way it is needed.

I think Iíve already spoken about how you can improve your competitive and financial position. I donít think I want to repeat myself, except for one thing. You often receive payments from leasing companies faster than from customers. We will pay you within 5 days from the time we get the documents in and normally that doesnít create a problem.

How easy is this leasing process? I think itís simple and a lot of this can be done by either you or the leasing company. You pick and choose whatever you want. You can talk to the customer about leasing or we can. You can call us for a quote and we will fax you a quote. (When I say we, itís generic for all leasing companies.) You can tell the customer what the rate is or we can deal directly with the customer. Whatever you want. Weíll have to get the credit approved, but as far as documentation of the lease, we can do the lease and send it to the customer or send it to you and you can give it to your customer. We donít have to see the customer. If the customer wants to change the lease, every leasing company will say the leasing company wants to talk to the customer; the software company canít agree to changes in the lease. Last thing is you receive payment from us. The process from a macro standpoint is relatively simple. From the micro standpoint, it can drive you bananas at time, but it really shouldnít.

Here comes another key - what does the leasing rep really have to know. Iíve had software execs say that I want my leasing sales reps to sell, I donít want them tied up in this leasing process and getting leases signed and understanding what it is. Well, it doesnít have to take a rep a long time to learn what he has to know about leasing. Iíd say 30 to 60 minutes is all they have to spend. They donít have to become leasing experts. All you are trying to do is have them feel comfortable with leasing. If you are not comfortable with something, you are not going to sell it, you are not going to use it. What do they have to know? Our experience is all they have to know about leasing is the customer is paying for a license over time, itís like a loan and thatís easy and it gives the sales reps a response to price objections.

The normal lease term ranges from 1 to 5 years, the average is about 3 years - itís not that dissimilar from the hardware industry. The customer owns the license at the end, they donít have to make any additional payments at the end of the lease, and the sales rep has to know a little bit about what are the benefits to the customer.

Most software leasing has been for large companies, Fortune 1000, strong middle market companies and state and municipal governments. A few lessors, including us, will provide the leasing for weaker middle market companies (not weak middle market companies), middle level state and local governments, and early stage companies. When you encounter ďproblemĒ companies, all leasing companies or banks are going to want some sort of additional collateral. There is no magic in this, the leasing companies donít all of a sudden make a bad credit into a good credit. But a good leasing company will really work with you and figure out if the transaction is doable.

In summary, software leasing is a great sales tool and it can increase your sales, shorten your sales cycle, enable your customers to get the software that they need now, increase your sales repsí commissions, and increase your companyís profits. We are just a phone call, e-mail, or an 800 number away. That is what software leasing is and thatís what leasing is.

If you want to get some more information, take a look at our Web site, www.lpilease.com. One of the software companies said to us, it was the best Web site theyíve seen from a leasing company.

Are there any questions or have I exhausted you?


© LPI Software Funding Group, Inc.   1275 Drummers Lane, Suite 200
Wayne, PA 19087   800-394-4574   sales@lpilease.com
  March 8, 2000