As a small business owner, you know that reliable equipment is the backbone of your operations. Whether you’re running a bakery, a graphic design studio, or a delivery service, having the right tools can make or break your success. While many businesses take good care of their equipment through maintenance and repairs, there comes a time when they need to be replaced. Since buying new equipment can be a big expense for a small business, they usually rely on equipment financing to acquire the tools and machines they need.
In this article, we will explore equipment financing options, and benefits of financing, compare equipment loans vs leasing, understand eligibility criteria, and learn about steps to apply for equipment financing.
What is Equipment Financing?
Equipment financing is an asset-based credit that enables business owners to acquire or lease equipment without using up their operational capital. With equipment financing, the equipment itself is used as collateral to secure funding. Rather than basing approval on a business owner’s credit score, lenders place a greater focus on the equipment’s worth.
Types of Equipment Financing
There are two forms of equipment financing: Obtaining a loan or leasing. Both provide a variety of periods and degrees of commitment based on the equipment companies require. The choice between obtaining a loan and leasing depends on your specific business needs and financial situation.
Applying for a Loan
When businesses acquire medical equipment, construction equipment, or other business-related equipment using a loan, that equipment serves as collateral for the loan. If the borrower defaults on loan payments, the lender has the right to seize the equipment. Personal guarantees may also be required, especially for small businesses with limited credit history.
Lenders may finance up to the full value of the equipment if it’s secured by substantial collateral. However, a down payment of approximately 20% of the equipment’s value is typically required. Business credit score, personal credit score, and financial statements play a role in determining loan eligibility.
Companies should carefully assess their ability to repay the loan. If they are uncertain about their ability to repay the loan, leasing the equipment might be a more suitable option. Remember to consider the repayment period, prepayment penalties, and flexible terms before agreeing to anything. Loan terms for company equipment can range from a few months to ten years. Interest rates vary based on factors such as the company’s credit history, business tenure, loan duration, and equipment value. Having excellent credit improves the chances of favorable rates.
Once the loan is repaid, the business owns the asset. This ownership advantage is a key benefit over leasing. Previously acquired equipment can serve as collateral for future financing needs, such as business expansion. Explore business credit cards, lines of credit, and industrial equipment financing options.
Leasing
Leasing is often easier to obtain than a loan. Particularly for short-term financing, leasing is also a more affordable choice. Unlike loans, leasing typically doesn’t require a down payment. Leasing involves lower interest payments compared to traditional loans. Leasing is advantageous for items that quickly become obsolete, such as medical equipment or outdated technology. Industrial equipment, office equipment, and construction equipment are common candidates for leasing. Leasing allows businesses more flexible terms to upgrade to newer, more advanced equipment over time.
Businesses should carefully review lease agreements, especially regarding any penalties for early termination. Some leases may require a personal guarantee. Some leases offer an option to buy the equipment after the lease term. The main benefit of leasing over obtaining a loan is that leasing eliminates any concerns about the equipment depreciating or becoming obsolete.
How equipment leasing works
At its core, equipment leasing is renting a crucial piece of machinery or technology for your business. Here’s the breakdown:
- Lender Purchase: First, a specialized lender (often equipment financing companies) acquires the equipment on your behalf.
- Lease Agreement: Next, you sign a lease agreement specifying the terms, duration, and monthly payments.
- Usage Rights: During the lease period, you get full access to the equipment, just like it’s your own.
There are three common types of equipment leases:
1. Operating Lease: You don’t own the equipment; you’re essentially borrowing it. Operating leases are usually short-term (6 months to 7 years). You’re responsible for maintaining and insuring the equipment. Operating lease payments are treated as operating expenses, not debt. You can return the equipment, extend the lease, or buy it after the end of your lease term.
2. Capital Lease: A capital lease is considered a purchase of an asset for accounting purposes. It mimics ownership, even though technically, it’s a rental agreement. It appears on your balance sheet as an asset. To qualify as a capital lease, the lease contract must meet at least one of the following criteria: The lease term must be 75% or greater of the asset’s useful life.
- The lease must include a bargain purchase option (i.e., you can buy the asset for less than its market value).
- You gain ownership at the lease period’s end.
- The present value of lease payments must exceed 90% of the asset’s market value.
3. Sales-Back Lease: This is when you sell your existing equipment to a lessor and then lease it back. Sales-back leases are often used to free up capital tied to owned equipment. Benefits of this option include cash infusion and continued equipment use.
Why Businesses Use Equipment Financing
Most companies, whether investing in machinery or cutting-edge technology, must balance the need for improving business operations while keeping their cash flow flexible.
A loan secured against machinery or technology is referred to as an equipment loan. This sort of financing makes it possible for companies to get the equipment they need. Lenders will often offer company funding that is secured by the equipment. The company will repay the money, with interest, in monthly payments. Equipment loans often have better interest rates and more flexible payment options than traditional loans. Plus, you usually aren’t required to put up extra collateral (like a house) to secure the loan.
Consistently paying back your loan payments contributes to building a positive credit history, benefiting businesses beyond the immediate financing need. Leasing and sale-leaseback arrangements provide significant tax savings compared to outright purchases as monthly lease costs are preferable to recording assets on the balance sheet.
As a result, equipment financing is an excellent instrument for small businesses to optimize operations, enhance cash flow, and strategically invest in assets that drive success.
Common use cases for equipment financing
There is always some asset that businesses would like to have in their operations, regardless of the industry. Equipment finance allows firms to acquire or lease the necessary equipment to function and expand. Again, everything from computer equipment to air conditioning can be funded. This way, a loan for equipment may assist firms in improving their cash flow and meeting their continuing costs.
Some common types of industry-based equipment financing include:
- Medical practice equipment financing
- Restaurant equipment financing
- Farm equipment financing
Pros and Cons of Buying Vs Leasing Equipment
When considering equipment financing options for your business, it’s essential to weigh the pros and cons of equipment loans and equipment leasing. Let’s delve into the key aspects of each.
Equipment Loans
Pros:
- With equipment loans, you gain ownership of the equipment once the loan is repaid. This can be advantageous if you plan to use the equipment for an extended period or if it’s a critical business asset.
- Interest payments on equipment loans are typically tax-deductible, providing potential tax advantages for your business.
Cons:
- Equipment loans often require a down payment or upfront costs. This can strain your cash flow, especially for expensive equipment.
- Some loans impose penalties if you pay off the loan early. Be aware of these terms before committing.
Equipment Loans
Pros:
- Leasing agreements usually have more affordable monthly payments compared to loans. This allows you to access necessary equipment without a hefty upfront expense.
- Leasing provides flexibility, especially for short-term needs or rapidly evolving industries. You can upgrade or replace equipment easily.
Cons:
- At the end of the lease, you won’t own the equipment unless you choose to purchase it separately. Leasing is ideal if you prioritize usage over ownership.
- Over time, leasing may cost more than purchasing due to cumulative lease payments.
How to Qualify for Equipment Financing
Typically, to secure equipment finance, small businesses must satisfy the following criteria:
- Minimum of one year in business
- At least $50,000 in annual income
- A credit score of at least 650
A credit score of at least 650 is generally expected. However, don’t worry if your credit score falls below this threshold. Some lenders may still consider your application if you can showcase solid cash flow and revenue over the past three to six months. Excellent credit can expedite approval.
Keep in mind that the exact requirements vary based on the lender and the type of equipment you’re acquiring. Each lender determines the maximum loan amount based on various factors such as the equipment’s lifespan, whether it’s new or used, and its overall value. The repayment terms of equipment financing are usually flexible, allowing you to match payments with your cash flow. Be aware of any prepayment penalties.
How Do I Apply for Equipment Financing?
Step 1: Determine if you need equipment loans or leasing.
- Equipment Loans: Opt for loans if you want to own the equipment outright. Loans are ideal for long-term investments, such as purchasing heavy machinery or specialized tools. You’ll make fixed monthly payments until the loan is repaid.
- Equipment Leasing: Leasing is great for flexibility. If you need equipment for a specific project or want to upgrade frequently, leasing might be the better choice. Leases often have lower upfront costs and allow you to return or upgrade equipment at the end of the lease term.
Scenario: Imagine you run a construction company. If you’re buying a crane that will be essential for years, a loan makes sense. However, if you need a temporary forklift for a short-term project, leasing is more practical.
Step 2: Know your eligibility criteria.
- Credit Score: Most lenders look at your personal and business credit scores. Aim for a credit score above 650 for better terms.
- Revenue and Time in Business: Lenders want to see stable revenue and a track record. Typically, you’ll need at least one year in business and a minimum annual revenue (varies by lender).
- Equipment serves as collateral, but some lenders may require additional guarantees.
If you’re a new business with limited revenue, focus on lenders who cater to startups. They understand the challenges you face.
Step 3: Research lenders and offers.
Not all lenders are created equal. Shop around to find the best fit for your needs. Consider:
- Traditional Banks: They offer competitive rates but may have stricter requirements.
- Online Lenders: These provide faster approvals and may be more lenient with credit scores.
- Specialized Equipment Lenders: Some lenders focus solely on equipment financing.
If speed matters, explore online lenders. If you value a personal relationship, visit your local bank.
Step 4: Gather the required financial documents.
Prepare the necessary paperwork to support your application:
- Income Statement: Shows your business’s profitability.
- Balance Sheet: Reveals your assets, liabilities, and equity.
- Business Plan: Explains your company’s goals and how the equipment fits in.
- Income Tax Returns: Lenders use these to verify your financial health.
If you’re organized, this step will be a breeze. If not, hire an accountant to help compile the documents.
Step 5: Submit the application and accept the financing terms.
If your application is approved, review the financing terms. Pay attention to interest rates, repayment schedules, and any fees. Once you agree, the lender will release the funds and then you can purchase or lease the equipment.
Where to get equipment financing
When seeking equipment financing, small businesses have several options to explore. Let’s delve into the key places where you can turn for equipment loans and leasing:
- Traditional Banks and Credit Unions: While they may have more stringent qualifications, they often offer competitive rates and favorable repayment terms. Some banks and credit unions also provide equipment leasing services. Reach out to your local branch to inquire about their leasing options.
- U.S. Small Business Administration (SBA): The SBA offers several types of equipment loan programs including the SBA 7(a) loan and the SBA CDC/504 loan. These loans are backed by the government and provide competitive rates. The CDC/504 loan, in particular, offers low-interest equipment financing.
- Online or Alternative Lenders: Alternative lenders like National Funding specialize in providing equipment loans. They often offer faster approvals and may be more lenient with credit scores. If you prefer flexibility, alternative lenders also offer equipment leasing which allows you to upgrade equipment periodically and manage cash flow effectively.
FAQs
Should I repair or replace business equipment?
When deciding whether to repair or replace equipment, consider repair costs, team needs, support availability, and impact on clients when deciding whether to repair or replace business equipment. For more details, read our article on repairing vs replacing equipment for small businesses.
How to grow your restaurant business with equipment leasing?
Accessing the latest kitchen equipment without the full upfront cost ensures that restaurants can stay competitive. Whether it’s state-of-the-art ovens, refrigerators, or specialized appliances, restaurant equipment financing allows them to serve customers with the best tools available.
How to grow your construction business with equipment financing?
Equipment financing can be a game-changer for construction companies. Equipment financing allows firms to expand their fleet without hefty upfront investments. By financing essential machinery like bulldozers, excavators, and cranes, companies boost operational capacity. For more insights, check out this comprehensive guide on equipment financing for construction companies here.
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Should You Buy or Lease Gym Equipment for Your Business?
Leasing gym equipment allows you to regularly upgrade your equipment without a large upfront capital investment. This can keep your fitness facility up-to-date and appealing to customers.
