Did you know equipment financing for startups and small businesses is available and widely used? That’s because one of the big reasons why young companies need financing is they need to purchase equipment. This can include:
- Vehicles such as cars, trucks or construction equipment
- Computers, printers and other office equipment
- Furniture and fixtures for offices or retail space
- Restaurant equipment, manufacturing equipment, agricultural equipment, or other stuff used to make stuff
- Medical equipment, specialized transportation equipment like boats or containers to provide services.
I’ve spent some time researching equipment financing, which was new to me. I’d like to share what I’ve learned.
Why Finance Equipment?
Plenty of businesses will use cash, sometimes, to buy small equipment. But according to surveys, there are two big reasons to finance equipment:
- improve cash flow
- avoid equipment obsolescence.
If you can spread outgoing cash flow for equipment over the life of that equipment, it keeps your cash balance higher and available for other uses. Obviously that will come at a cost – interest payments or financing charges – but for many companies it’s worth the expense.
The other thing to consider is equipment obsolescence, which in particular comes into play for leases. If you need computer equipment in particular, it may make sense to lease rather than buy with a loan or credit card, so that you can replace it with newer models when the lease runs out.
Four Ways To Finance Equipment
There are four distinct options businesses use for financing equipment purchases:
- equipment loans
- equipment leases
- lines of credit
- credit cards.
An equipment loan is similar to other secured term loans such as mortgages. They have a defined term (duration in months or years), and because they are relatively short they usually have a fixed interest rate and a fixed monthly payment.
The basic difference in equipment loans versus leases is who owns the equipment: you (loans) or the financing company (leases)?
And that difference creates a fork at the end of your payment term: either you get to keep the paid-off equipment (loans) or the financing company takes it back (leases).
So the first step in comparing loans vs. leases is to ask whether this equipment will still be used long after you pay it off.
A line of credit is unsecured, and is usually more expensive than a loan secured by the equipment. It can still be useful for funding equipment that is not otherwise financeable.
Finally, credit cards are also commonly used to purchase and finance equipment. Like a line of credit, credit cards are unsecured (no collateral) and tend to be even more expensive than a line of credit.
Which type of financing is used varies both by purchase size, and size of the company.
As the following chart indicates, credit cards are the number one method of financing equipment purchases under $25,000, followed by leases and lines of credit. Secured equipment loans are seldom used for these “small” purchases. Click on the graph to see the details.
It’s not surprising that different types of financing are available to larger companies. From the same surveys, here’s how financing options change for “small” companies (fewer than 50 employees) and somewhat larger companies (51-100 employees).
The big lesson here: bigger companies rarely buy equipment with cash or credit cards. Secured loans and equipment leases are used when available.
Four Sources of Equipment Financing
As you’re thinking about what type of financing might make sense, you also need to think about who will provide the financing. There are four types of organizations:
- Equipment manufacturers or vendors
- Non-bank, independent financing companies
As the chart below indicates, banks are #1 in the market overall. However, they focus on financing equipment for profitable companies with good credit.
Many manufacturers or suppliers of expensive equipment also have finance organizations. From what I’ve read, if the maker of the equipment you’re buying offers financing, that’s often your best choice. This is particularly true in challenging economic times, because the equipment makers are strongly motivated to generate sales, and attractive financing can make a difference.
There are also many non-bank financial institutions that are independent of the equipment makers. These make sense especially for smaller or younger businesses that aren’t yet strong financially. Fintech (online) equipment companies in particular are growing rapidly in both secured equipment loans and leasing.
We’re not sure who is “other.” But apparently they’re out there!
Four Equipment Financing Questions To Ask
As you’re starting to narrow down your choices, here are four questions to ask before you spend lots of time looking at specific options.
1) Does this equipment tend to hold much or most of its value over time?
Especially for expensive new equipment it’s worthwhile to find out if there’s a market for used equipment. That will help in at least two ways:
- You can see how much value is retained over time, which can affect your thinking about loans versus leases
- You can think through whether you really need new equipment, or whether used equipment will be sufficient.
2) How many years will this equipment last?
Equipment such as vehicles, or durable industrial equipment, can last for a long time. Other equipment such as computers and cheap printers become obsolete or wear out relatively quickly. This will also impact your thinking about whether to get a secured equipment loan, or lease (if available).
3) Do the manufacturers or retailers offer financing?
As mentioned above, manufacturer financing is often the best choice. But it’s also true that retailers such as office supply companies offer financing. Because these sources of financing are motivated to increase sales, their financing terms are often the most attractive available.
4) How’s your credit and your profitability?
The good news is that not-so-great credit scores and so-so profitability aren’t necessarily barriers to securing equipment financing. Often the non-bank equipment funders and equipment manufacturers are more focused on how much value is retained by the equipment over time.
Of course, just like all loans, equipment loans must be paid back regularly over a long period of time. Make sure the equipment will be generating enough revenue to pay for itself!
Four Equipment Financing Money Issues
As you narrow down to specific equipment financing offers, here are four issues to consider.
1) How much of the purchase price can be financed?
Sometimes you can finance 100% of the purchase price, but that’s not always the case.
2) How does the term of the loan or lease compare with a) its useful life and b) your own plans to use the equipment?
You don’t want to keep paying for old obsolete equipment. On the other hand, if you can pay for equipment in five years and it’ll last for 15, that will strongly suggest that a loan is better than a lease.
3) What is the interest rate? Is it fixed or variable?
Equipment financing interest rates can range widely, from 8% to 30%. Usually they are fixed, but credit cards and lines of credit can sometimes be variable. How might that change over the life of paying it off?
4) What are the tax and accounting implications?
If you’re buying a big piece of equipment, it’s a good idea to talk to your accountant about both tax and accounting implications of loans versus leases. I’m not an accountant so I won’t try to fake it – I just know there are some important issues that vary by individual company tax situations.
Also, if your company has audited financials, the new FASB rules for leasing means that any leases of one year or more have to be reported on balance sheets for non-public companies beginning in 2020. And it turns out that mapping specific lease terms to their meaning for accounting statements isn’t trivial. Most of you won’t have to worry about that now, but if you get big and successful you may!