What is Equipment Financing?
Equipment financing refers to a loan or lease used to acquire business equipment. This can include any tangible asset other than real estate, such as office furniture, computer hardware, manufacturing machinery, medical devices, and company vehicles.
Understanding Equipment Financing
For a startup or early-stage company, equipment financing may be an essential step in getting the business going.
Since equipment financing is generally used for acquiring expensive equipment, it results in a considerable financial obligation. As a result, business owners and company executives need to thoroughly evaluate any equipment financing arrangement and aim to secure the most favorable terms possible.
There are two main options for equipment financing: taking out a loan to buy the equipment or leasing it. The best choice for your business will depend on various factors, including your business’s credit rating (which influences the interest rate on borrowed funds) and the expected useful life of the equipment being financed.
Purchasing Equipment with a Loan
When you use a loan to acquire business equipment, the equipment itself serves as collateral. This means the lender has a lien on the equipment and can repossess it if the borrower defaults on the loan payments.
Since the equipment provides significant collateral, lenders, such as banks, may offer financing up to 100% of the equipment’s value, though it's more common for loans to cover up to 80%. As a result, borrowers may still need to provide a substantial down payment, even with equipment financing.
It's crucial for business owners to assess their ability to meet loan payments carefully. If there are concerns about keeping up with these payments, leasing the equipment might be a more suitable option.
Loan terms for business equipment can range from several months to over 10 years, with interest rates varying widely—from as low as 4%-5% to as high as 30%. The key factors influencing these rates include the credit rating of the business or owner, the business’s operational history, the loan term length, and the anticipated depreciation of the equipment.
A significant advantage of purchasing equipment, rather than leasing, is that once the loan is fully paid off, the business owns the asset. This ownership can be beneficial if the business needs to secure additional financing in the future, such as for expansion, as the previously purchased equipment can serve as collateral to obtain better loan terms.
Equipment Leasing
Leasing equipment instead of buying it can be appealing for several reasons. First, obtaining a loan to purchase equipment might not be feasible if the borrower cannot afford the required down payment or doesn't qualify for the loan. Additionally, leasing is often more cost-effective, particularly for short-term needs, as it typically requires no down payment and involves lower interest costs.
Leasing can also be advantageous depending on the type of equipment. For assets that quickly become outdated, such as computers or vehicles, leasing allows businesses to upgrade to newer models over time. However, if this is your strategy, it's important to carefully review lease terms, including any penalties for early termination.
Some leasing agreements include an option to purchase the equipment at the end of the lease term. Business owners should consider whether they eventually plan to own the equipment.
The main benefit of financing equipment through a loan is that you own the asset once the loan is paid off. In contrast, the primary advantage of leasing is avoiding concerns about the equipment becoming obsolete and losing value.
Comments