Business equipment can be expensive. Even smaller costs, such as routine maintenance, add up quickly. Equipment financing is a way of reducing the upfront financial burden of buying or replacing business machines.
Equipment financing refers to using a loan, line of credit or lease to obtain business equipment.
“Almost any type of equipment can be financed if used for a business purpose,” says Mark Kelly, senior vice president and business development manager at Univest. “Whether it’s health care equipment, industrial, construction, energy conservation, technology, titled vehicles, furniture or landscaping equipment, all businesses have equipment needs.”
Here’s more about equipment financing to help you compare your options.
[Read: Best Small Business Loans.]
Pros and Cons of Equipment Financing for Small Businesses
Pros:
— Conserve cash flow. Equipment financing frees up cash for capital and operating expenses. “Retaining capital and having cash in our current environment could be paramount to a business’s lifeline,” says Steve Scott, chief operating officer of Engage PEO, a human resources outsourcing firm.
— Hedge against inflation. “Payments are fixed for the entire term of the loan or lease,” Kelly says. “When adjusted for future inflation, the net cost will actually decrease while gross revenues generated by the equipment increase.”
— Lease to own. You may own the equipment outright or be able to purchase it at the end of the lease.
— Enjoy tax advantages. Write off the entire purchase price of qualifying new and used equipment in the same tax year that it is placed in service. You could be able to claim a deduction of up to $1,080,000 in 2022.
Cons:
— Default risk. If your loan is secured by a blanket lien or personal guarantee, the lender can claim your business or personal assets if you default. That includes the equipment you financed.
— Down payment requirement. Depending on the type of financing, you may need to make a down payment on the loan: typically 20%.
— Obsolete or broken equipment. You could end up paying for equipment that is not working or not helping your business.
— Limited financing for new businesses. Equipment financing can be hard to secure for newer businesses. “Businesses need to be established, usually at least two years,” Kelly says.
Always analyze the costs and benefits of equipment, says Jeff Nager, executive vice president and head of commercial lending at The Bancorp Bank. Ask yourself whether to use business or personal cash to purchase the equipment, he says.
“That may take away needed working capital but keeps the business from having a payment,” Nager says. “If you lease or get a loan, you can preserve cash and build credit, which is very important for many small businesses.”
How Can You Qualify for Equipment Financing?
Qualifications for equipment financing vary among lenders.
Borrowers can generally qualify with at least one year in business, $100,000 or more in annual revenue, and a credit score no lower than 550 to 600, according to small-business lender BlueVine. Guidelines from the online lending marketplace Lendio are $50,000 or more in annual revenue, a credit score of 650 or better and at least a year in business.
Excellent credit is best for an equipment loan, according to small-business lender Kabbage. The lender also says to have a solid business plan, an updated resume, and your personal and business financial statements in order.
[Read: Best Unsecured Business Loans.]
What Are Your Equipment Financing Options?
Term Loans
A term loan is a traditional business loan that lets you borrow a lump sum and repay it at a fixed or variable interest rate, much like a mortgage or auto loan. You may be able to borrow up to $1 million, according to Funding Circle, a peer-to-peer small-business lender.
“A fixed-term plan has an interest rate that doesn’t change throughout the life of the loan,” Kelly says. “Because the rate doesn’t change, the payment remains the same, resulting in an easy budgeting process for the business.”
The annual percentage rate on term loans ranges from 6% to 25%, Scott says, with a repayment period of one to five years. “Approval and funding are quick, at two business days in many cases,” he says.
But consider loan fees, which can include origination, underwriting and packaging fees, plus collateral or personal guarantee requirements.
Equipment Loans
Business equipment loans are specifically for equipment purchases. You can get an equipment loan from a traditional bank, an online lender or an equipment financing and leasing company.
With an equipment loan, you can finance up to 100% of the equipment’s value, Scott says. “The annual percentage rate can be anywhere from 8% to 30%, with repayment up to the life of the equipment,” he says.
You may need to make a down payment of 5% to 20% of the purchase price. The upside is that an equipment loan can have a fast turnaround.
Approval and funding could take “as little as two business days because the loan is secured with the equipment,” Scott says.
The equipment acts as collateral, which reduces risk for the lender and opens a door for startups to qualify.
SBA 504 Loans
The Small Business Administration’s 504 loan program features fixed-rate loans of up to $5 million for long-term assets, such as a building or equipment or facility improvements.
SBA 504 loans are available through certified development companies, or CDCs, which are community-based partners regulated and certified by the SBA. A CDC finances up to 40% of the loan; a third-party lender, such as a bank or credit union, finances 50%; and the borrower contributes 10%. The portion from the CDC is backed by the SBA.
— Operating in the U.S. or its possessions as a for-profit company.
— Having a tangible net worth of less than $15 million.
— Reporting an average net income of less than $5 million for the last two years.
You can choose from 10- or 20-year repayment terms. APR is determined by the rate for five- and 10-year treasury bonds, which is generally lower than bank rates, Scott says. Note that the loan will include an upfront guarantee fee and an annual service fee.
If you need financing quickly, this might not be the solution for you. One downside to SBA 504 loans is that “approval and funding can take five to eight weeks or longer,” Scott says.
Small-Business Line of Credit
A business line of credit allows you to borrow cash as needed instead of as a lump sum. Access funds up to your credit limit, repay and borrow again, similar to a credit card. You will be charged interest only on the amount you borrow.
The lender will set a limit on your small-business line of credit, usually between $10,000 and $100,000. You may be required to secure a line of credit greater than $100,000 with a blanket lien or certificate of deposit.
Requirements for a business line of credit vary. Lenders may consider personal and business credit scores and financial statements, plus your industry, time in business and annual revenue, according to Nav, which matches small business with loans and credit cards.
APRs can be fixed or variable and range from 7% to 36%, Scott says. “Approval and funding are quick, at two business days in many cases,” he says.
Small-Business Credit Card
Another equipment financing option is to use a business credit card.
Business credit cards offer a couple of advantages compared with equipment loans or leases. Applications for cards are less time intensive than loans, and cards may have 0% APR offers and ongoing cash back rewards, miles or points.
Disadvantages of financing equipment with a small-business credit card are lower limits and higher APRs than other methods. APRs range from 11% to 24%, Scott says.
If you don’t pay your bill on time, you could be looking at much more expensive equipment over the long term. You may want to reserve your business credit card for less-expensive equipment, such as computers and desks, instead of costly large items, Scott says.
How Do I Apply for Equipment Financing?
The process of applying for an equipment loan is similar to obtaining other types of loans.
Begin by identifying and evaluating potential lenders. But first think about why you need this equipment and how it could affect your revenue, profit and overall business, suggests small-business lender Fora Financial.
“Work with the vendor, your bank and even your accountant to discuss how the payments will impact your business,” Nager says.
Timing the purchase correctly is essential. “Buying additional equipment too early can lead to spending significant dollars on an item not being fully used,” Nager says. “And waiting too long could mean the loss of business or a contract.”
Check eligibility requirements, and make sure you will qualify. Criteria often include credit score, time in business and revenue but vary by lender. If the lender needs a down payment, can you afford it?
Now you can apply, but do not apply to more than one lender at a time because multiple hard credit pulls can hurt your personal and business credit scores. Your lender will likely look at your time in business, credit history and business plan, according to JPMorgan Chase & Co.
[Read: Best Bad Credit Loans for Small Businesses.]
Equipment Financing vs. Equipment Leasing
The difference between financing and leasing equipment is that when you finance equipment, you own it until you choose to get rid of it. Leasing gives you access to the equipment only for the duration of the rental agreement, with an option to return the equipment, buy it or renew the lease.
The two most common types of equipment leases are capital leases and operating leases. Capital leases are for long-term access to a major piece of equipment, and you will be responsible for maintaining the equipment. Operating leases are for short-term rentals and, unlike capital leases, can be canceled before they expire.
Which type of lease is better for your business will depend on the equipment and your business needs. A capital lease, also known as a fair market value lease, may be a good choice if the technology you use is constantly evolving.
“FMV leases give small businesses a way to easily upgrade to new equipment when the lease ends,” says Justin Tabone, senior vice president of originations, vendor equipment finance, TIAA Bank. “But a finance lease might be better for equipment such as linear accelerators. They tend to have long, useful lives, and when the lease ends, small businesses may want to keep that equipment.”
Leasing equipment may be best for your business if:
— You have short-term equipment needs.
— You must update technology frequently.
— You are tight on cash.
Leasing can allow you to get equipment and pay no down payment and low upfront costs, make low monthly payments, and deduct lease payments to reduce your taxable income. At the same time, you incur costs without building equity in the equipment and may be locked into the lease for longer than you need the equipment.
Financing equipment may be best for your business if:
— You plan to keep the equipment for a long time.
— You use the equipment constantly to generate revenue.
— Your company’s cash flow is strong.
The benefits of buying are that you own the equipment, you can sell it if you don’t need it, and you can benefit from tax deductions. However, your monthly payment may be higher than a lease payment, you might need to come up with a big down payment, and outdated equipment may be hard to sell.
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How to Finance Equipment for Your Small Business originally appeared on usnews.com
Update 02/15/22:
