Lease Accounting: The $1 Billion Software Market You’ve Never Heard Of (5 min)

August 19, 2020

Introduction: The Journey To $1 Billion

$400 Million. the current size of the Lease Accounting software market.

$1 Billion. the expected size of the market... in less than 5 years from now.

$0. The size of the market just 10 years ago.

$1bn for Lease Software!? What the heck is Lease Accounting, and where did it come from?

In 2019, New Lease Regulations shift $5 trillion onto Balance Sheet

A recent article took a deep dive into the new Lease Accounting standard:

The Only Benefit Of The New FASB Lease Accounting Rule Is Creating More Work For Accountants (Sept 2019).

Is the author correct?

One thing he’s right about: these regulations will impact nearly every business in America. Whether it’s 1 hour or 1 month, every accounting leader will have to dedicate time to this.

What are these new regulations, and why will they drive this growth in the market?

For decades, leases were handled as an Expense - ie. off of the Balance Sheet. An office lease got signed, or a truck got leased, and you paid the regular expenses monthly. Just like any expense: a SaaS agreement, your marketing agency, the water cooler delivery service.

In 2001, in the wake of the Enron scandal, the SEC began evaluating “off-balance sheet” activities. 👉

In 2006, a change was proposed to close the lease loophole. 

In 2009, the FASB and IASB issued a Discussion Paper that proposed to put leases on the balance sheet. 

In 2013, the standard was solidified. 

In 2016, FASB published ASC 842 (under GAAP) and IASB introduced IFRS 16 (under IFRS).

To simplify, these new standards change 3 key things:

  1. Leases Go On The Balance Sheet. Instead of a straight line expense (ie. one-time setup), the lease payments would be forecast over their expected lifetime. Then, a complex test would be administered, including applying an interest rate. The resulting Liability would be calculated and updated regularly (ex. Monthly journal entries).
  2. More Data Required from Lease Contracts. Instead of just a Start Date, End Date, and basic Payment Stream, GAAP & IFRS would now require multiple payment components, negotiated incentives, allowances, options, terminations and other items buried into the contract.
  3. Annual Disclosures Required. Instead of a small asterisk on a 10K filing, a 20+ line quantitative disclosure would be required that speaks to the nature and risk of leases.

This ☝️ is the shift that sent an estimated $5 trillion onto the Balance Sheet.

When is the Deadline?

Public companies were required to adopt January 2019, including both GAAP & IFRS.

Private companies were required to adopt January 2020. 

However, the standard for private companies got delayed** until January 2021.

**Interestingly, the FASB Chair Russ Golden said he was ‘disappointed’ that many software companies weren’t ready for the lease accounting rules.
Technology Could Slow Pace of New Accounting Rules (WSJ, June 2019)

Can’t Companies Just Do This With Spreadsheets?

Perhaps 🤔. If they have less than 10 leases. Or a small portfolio of very simple leases. But once you get past 10 leases, the task of updating monthly journal entries and patching annual disclosures requires rule-based software. Keep in mind the standard goes beyond office leases and includes equipment - cars, forklifts, servers, telecom, medical devices, etc - and leases embedded within service contracts.

Any significant change in a lease - term, payments, options - requires a company to apply modification accounting, which adds a layer of complexity that a spreadsheet may not be able to handle.

For public companies, they may need to show more information in a SOX regulated environment - such as User Controls and Audit Trail.

So, Companies Are Forced To Use Software?

Yes. Lease Software allows you to manually type in your lease data, answer a few questions about each contract, and *poof!* out comes your monthly journal entries and disclosures.

Is This Why Lease Software Is a $1bn Market?

Yes. Imagine you're a software company that specializes in GDPR compliant software for websites, and the deadline is coming up. Or N95 masks in the wake of Coronavirus. You’re going to be in demand.

How Are Investors Responding?

If they know, they know. Here is the list of Corporate Development activity in the past 24 months:

$125m+ in known investments were made in a 2 year window, not including 2 acquisitions and debt financing. 💸

Is this a Private Equity market? Or are there VC firms too?

As we see above, all of the investment comes from Private Equity firms focused on legacy businesses. This may be related to 1) Maturity of the businesses, and 2) Private Equity’s understanding of compliance-driven businesses, often in back-office operations. Here are the years when the most established lease software companies were founded 🛠️:

1992 Dodge Caravan

VCs, on the other hand, tend to focus on upstart companies whose growth is supported by innovation and disruption. The above players fall into a category of software companies whose growth is bolstered by this regulatory event, regardless of whether they originated in Real Estate, Equipment, Retail Leasing, or other adjacent verticals.

So far, we see no known VC investment into this space.

How Does the ERP Ecosystem Change?

In short, more manual entry - and loosely integrated.

Oracle and SAP did not bring a solution to market. Nor did Microsoft, Sage Intacct, Netsuite, INFOR, Workday and others. Some have ISV partners who created modules within their API ecosystem.

It’s expected that there will be an additional $1bn+ annual labor market related to entering and maintaining leases into ERPs or sub-ledgers.

There are even global accounting firms who offer managed services around maintaining a manual entry process and an ERP ecosystem. 

How do Accounting Firms Capitalize?

The accounting services industry is a $200bn+ annual market largely comprised of audit, tax and consulting services. Over $150bn is attributed to the Big 4 accounting firms: E&Y, PwC, Deloitte & KPMG. Accounting firms are taking mixed approaches: some see it as an opportunity to commit resources (ie. people) through manual tasks such as contract reading, data entry, spreadsheet uploads. Others view it as an opportunity to build, license or partner with technology. Some are even leveraging advances in AI and Machine Learning to reduce the total cost of ownership for their clients.

In the Big 4 arena, each firm has their own approach. 

As you move past the Big 4, other firms are entering the Lease Accounting market:

A $5 Trillion Accounting Shift Creates a $1 Billion Software Market + $$ Million Labor Market

As you can see, a small accounting shift has sent $5 trillion on the balance sheet and a $1bn lease software spend market for companies. This has also created a new labor market to manually manage the lease data around the ERP, and accounting firms to check the work.

So Does Seeking Alpha's article have merit?

(The Only Benefit Of The New FASB  Lease Accounting Rule Is Creating More Work For Accountants)

During a time where operational efficiency is more critical than ever, we keep encountering situations like at Genesis Healthcare:

CFO Tom DiVittorio said his "biggest regret was spending too much time searching for a software tool to accommodate all of Genesis’s leases." (WSJ, August 2019)

We'll continue to watch this market evolve.

Bonus: Beyond Compliance, Is There Value in Organizing Lease Data?

One of the mandates of CFOs and Controllers is cost control. The average Fortune 1000 company has between $100m and $1bn in lease liabilities. So managing these in software - rather than PDFs or spreadsheets - can bring powerful efficiency. 

The new regulations could usher in an era of smarter operational efficiency for accounting leaders that will make that otherwise eye-catching $1bn market size just the tip of the iceberg.

More posts you might like

Still manually entering contracts?

Get Early Access
© 2019 SMRT Corp, all rights reserved