One of the most straightforward options is equipment financing when you need to make purchases for your business. It's often easier to qualify for because the physical assets act as collateral. It's only for some, though, as the definition of equipment varies from person to person.
This article breaks down everything you need to know about equipment financing so you better understand this product and can begin to consider if this is right for your business.
What is Equipment Financing?
Equipment financing is one of the many ways small businesses can finance significant purchases for their business. It involves using a loan or lease to purchase or even borrow a physical asset for your business. Because there are many types of equipment — and many definitions of the word equipment — some lenders only finance certain types of equipment.
The main difference between equipment financing and other small business loans and funding options is the emphasis on physical, tangible assets. Other types of financing, like working capital loans, can be used for non-physical business expenses like payroll or rent/mortgage.
Equipment financing is strictly intended to fund the purchase or lease of tangible commercial equipment. As a result, the piece of equipment acts as collateral. If you default on payments, your lender can seize the equipment. Since the physical asset is the collateral, equipment financing can be easier to qualify for.
How Does Equipment Financing Work?
If you are new to the idea of equipment financing — or need a refresher on the topic — here's a breakdown of the process.
First, you must decide what equipment you need and if it qualifies for equipment financing. We'll discuss the types of applicable equipment momentarily. Then you'll determine if you will purchase the equipment or lease it — we'll also discuss this in more detail shortly.
Choosing the right lender is the most crucial step because you need a financial partnership, and that's where we excel. We believe in developing relationships with our customers so we can make the best decisions for your business financing needs.
Once you choose a lender, in many cases, the lender will directly pay the vendor for the equipment, and you will make payments to the lender. It's very much like purchasing a car.
You don't get the pink slip and become the official owner of the vehicle until you pay the loan off — it's the same with equipment financing. Again, if you default on your payments, the lender can seize the equipment.
What Type of Equipment Can You Finance?
The most frequent issues arise when businesses try to obtain equipment financing for equipment that doesn't match the lender's definition or their specialty.
At Midwest Business Funding, equipment that qualifies for equipment financing includes physical assets well into the thousands of dollars and are heavily relied upon for the business's success. Examples of equipment include but are not limited to the following:
- Restaurant ovens, ranges, and refrigerators
- Heavy machinery
- Construction equipment or vehicles
- Dozens of computers for a library or computer lab
- Medical and dental equipment like x-ray machines
- Farm and agriculture equipment
Should You Get a Loan or Lease? Which One is Best?
Before you procure additional equipment for your business, the top decision is whether to pursue a loan or a lease. Each option has advantages and disadvantages, but one may be a better choice for your business.
Equipment Loan Financing
As mentioned earlier, if you buy the equipment outright with a loan, the lender technically owns it until you pay off the balance in full, much like an auto loan. Since the equipment serves as collateral, many lenders will lend anywhere from 80% to 100% of the cost of the equipment.
Depending on the price of the equipment, you may still need a sizable down payment ready to make your purchase. For example, if your heavy machinery costs $100K and the loan is 80%, you'll still need to put down $20K.
The benefit of pursuing an equipment loan is that once you pay it off, you own it. If you ever need an additional loan in the future, you can use the equipment as collateral, potentially reducing your APR or down payment. The downside is if you miss a payment and default, you can lose the equipment.
Equipment Lease Financing
The alternative to an equipment loan is to pursue a lease. There are several reasons why a lease may be the more attractive option. For starters, you may not be able to come up with the necessary down payment.
When you lease, you typically do not need a down payment; you're technically paying to borrow the equipment. Additionally, when you lease, you may be able to write off the lease payments on your taxes. Discuss those particulars with your accountant because it's not always possible, but it often is.
Another reason you may decide to pursue a lease is if the equipment quickly becomes obsolete. Technology constantly changes, so leasing may be a better option if you want the latest and greatest computers or servers running your business. Read the fine print before you sign, as many have terms you cannot break without an additional fee.
Some leases allow you to purchase the equipment at the end of the lease, which can be the best of both worlds. An example is a fair market value lease, where you can return the equipment at the end or purchase it for its fair market value.
The Pros and Cons of Equipment Financing
As with any form of financing, equipment financing has pros and cons. Here are the top few for your consideration.
Pros of Equipment Financing
- It gets you the equipment that you need without having to save the total cost
- Depending on the loan or lease, you may not need to put anything down
- If you lease, you can get up-to-date equipment whenever necessary
- Predictable monthly payments that you can budget for
- It can help you build your business credit
Cons of Equipment Financing
- Sometimes requires a hefty down payment of 20%
- It is more expensive than buying the equipment outright
- Making the monthly payment can impede cash flow
- You can lose the equipment if you default, and it will damage your credit
How To Qualify For Equipment Financing
Qualifying for equipment financing will vary, depending on each lender's requirements. You can generally expect to have your business and personal credit run and impact the credit decision. Some lenders may also require you to have a business plan with concrete examples of how this equipment will further your business goals and increase revenue.
The number of years you have been in business and annual revenue can be additional factors in the decision process. Established companies that need to upgrade their equipment may have an easier time obtaining an equipment loan or lease, but that's not to say new businesses cannot procure one — that's where having a solid personal credit score comes in handy.
The best place to start is by filling out a quick form and talking with us to discuss your options.
When Is Equipment Financing Right For Your Business?
Equipment financing can be an excellent investment in your business and yourself. It can be easier to get the resources you need to keep your business growing without making a huge investment all at once.
Additionally, pursuing this business funding can help reduce long-term costs by bringing other services in-house. Let's say you are a photographer, and you've been having a print shop print and assemble all of your albums. Investing in a commercial-grade printer and related accessories means you will no longer have to use the print shop, which can save money in the long run.
Conversely, suppose the equipment you purchase does not directly contribute to your ability to make money. In that case, it can hurt your business twofold because it's not contributing to your profit margin and reducing your cash flow simultaneously.
Before considering equipment financing, ask yourself these questions:
- Will the equipment I'm interested in, generate income?
- Is the cost significant enough to warrant a loan or lease?
- Do I need the equipment now, or can I save up and buy it later?
- Can I afford the 20% down payment, if necessary?
- How much of a monthly payment can I afford?
No need to worry about these questions too much, as we'll walk through the process with you, but these are here to help you consider if equipment financing is the right path for your business.
Connect with us today to get started and learn more.