Whether you’re running a restaurant, a construction company, or even working out of your home, chances are your business needs equipment to perform its basic functions. If you can’t pay for equipment out of pocket, your best option may be to seek equipment financing.
Both large and small businesses use equipment financing as one of the most important ways to invest in capital while managing cash flow and the company’s balance sheet. Equipment financing allows companies to acquire equipment while avoiding many of the uncertainties often associated with new equipment acquisition.
What is Equipment Financing?
Equipment financing is the use of a loan or lease to purchase or borrow hard assets for your business. This type of financing can be used to purchase or borrow any physical asset, such as a restaurant oven or a company car. There is an enormous number of variations on equipment financing that cater to specific types of businesses and equipment.
The best way to understand equipment financing is by looking at a physical asset. This could be anything from computers and smartphones to trucks and trailers. Unlike a working capital loan, the asset you’re purchasing serves as its own collateral. For this reason, equipment financing tends to be a more cost-effective and lower-risk way to acquire equipment than other forms of financing.
How Does Equipment Financing Work?
it’s important that before contacting your financer you have an idea of exactly what you are looking to buy. You’ll also want an idea of who you’re planning to buy it from. In most cases, your equipment financer is covering either all or a percentage of the cost of your equipment and will directly pay the vendor for the equipment without the money ever entering your bank account.
The length of time your equipment is financed for will vary depending on what type you choose, but it’s usually anywhere between two and seven years. Over that time, you’ll typically make monthly payments to your equipment financer, paying off the principal plus interest.
Loaning and Leasing
There are two common ways to finance equipment: through a loan or a lease. While both give you access to the equipment needed to run your business, there are many differences between the two methods.
Equipment loans are taken out to purchase equipment, with the express purpose being that you will soon be purchasing it. Typically, the equipment secures the loan — if you can no longer afford to pay the loan, the equipment gets collected as collateral.
For business owners who can’t afford to make the purchase outright, these loans are a great option. They allow you access and control of an expensive piece of equipment long-term without having heavy debt load on your company’s bottom line. A lending institution might agree to extend most of the capital so that you can pay in periodic increments.
Leasing may be the perfect solution for you if your company needs to replace equipment often or doesn’t have enough capital available. It’s also more likely to cover additional soft costs associated with shipping and installing the equipment.
Instead of borrowing money to purchase the equipment, you’re paying a fee to borrow the equipment. The leasing company technically maintains ownership of the equipment but lets you use it.
Lease arrangements can vary depending upon your company’s needs. In order to keep up with the latest trends and technology, many companies lease their equipment instead of buying it. This allows them more freedom to upgrade as needed or when newer models are released.
If you want to own the equipment, some lessors offer the option of purchasing the equipment at the end of the term.
The two major types of leases are finance and operating. A finance lease functions a bit like a loan alternative and is used to finance the equipment you want to own long term. An operating lease is closer to a rental agreement that returns the equipment to the lending company at the end of the lease. Both types have many variations. Here are a few common types:
- Fair Market Value Lease – you make regular payments while borrowing the equipment for a set term. When the term is up, you have the option of returning the equipment or purchasing it at its fair market value.
- $1 Buyout Lease – you’ll pay off the cost of the equipment, plus interest, over the course of the lease. In the end, you’ll owe exactly $1. Once you pay this residual, which is little more than a formality, you’ll fully own the equipment. Aside from technical differences, this type of lease is very similar to a loan in terms of structure and cost.
- 10% Option Lease: This lease is the same as a $1 lease, but at the end of the term, you have the option of purchasing the equipment for 10% of its costs. These tend to carry lower monthly payments than a $1 buyout lease.
Is Equipment Financing Right for You?
The key to success is knowing how and when you can make use of equipment financing. This includes such things as vehicles, computers or machinery that may be utilized by your business for its operations
Equipment financing can help when you need expensive equipment but can’t afford to purchase that equipment upfront, if you need to replace your equipment frequently because it has a short lifespan, or you always need the latest in technology.
There are many benefits to equipment financing, such as:
- Preserving working capital – equipment financing is a source of funding that allows you to not only keep your cash, but use it as working capital for other areas of your business such as expansion, improvements, marketing, or R&D.
- Managing risk – equipment financing can help mitigate the uncertainty of investing in a capital asset your business needs until it achieves a desired return, increases efficiency, saves costs, or meets other business objectives.
- Flexibility in terms and payments – equipment financing may hedge inflation risk because you can delay paying for your equipment in today’s dollars. In addition, either a lease or loan can lock in the rates that exist on the date of the closing.
- Potential tax advantages – tax-oriented leases are a great way for businesses to take advantage of lower rent prices, as the lessor retains title and depreciation. A tax-oriented lease is a transaction that includes the value of tax benefits.
Whether leasing or buying, equipment financing can help you build credit, be an affordable option, and allow you to get the equipment you need for your business to grow.