For small businesses that depend on machinery or vehicles for their day-to-day operations, funding that aspect of the company can be a real challenge.
Especially for a fledgling business that is attempting to gain a foothold in its particular market, the responsibility of paying for the heavy equipment needed to keep the company running can be a daunting issue.
What is an equipment loan?
A loan that is secured for the purpose of buying equipment, an equipment financing loan is secured by the equipment itself. A business that can’t afford to pay off the loan would end up surrendering the equipment as collateral.
If cash flow impedes the purchase of vehicles or machinery, small businesses can turn to small equipment loans in order to finance the heavy-duty parts they need to make a go of things. A number of providers ranging from traditional banks to alternative lenders are available to lend money for equipment. The rates for an equipment loan could be anywhere from 6 percent to 9 percent.
Businesses must come up with a down payment of between 10 and 30 percent in an equipment loan agreement. The lender will finance the remainder.
When a business’ equipment starts to wear out or become outmoded, and the company still needs that type of equipment to operate at maximum efficiency and productivity, then the business needs new equipment and a way to pay for it.
A small business operating on a limited budget may see financing equipment as an attractive option to preserve its cash on hand by dispersing the funding of needed equipment over several months or years in predictable, equal payments.
Assets whose value is unlikely to depreciate much are suitable subjects for equipment financing.
For many small businesses, equipment can be financed up to 100 percent of its value. Most lenders will set the term of the loan equal to the equipment’s expected useful life. Most computers and software have an expected useful life of between three and five years, according to actuarial website AssetWorks.
Why should you apply for an equipment loan?
There are three reasons business owners would apply for an equipment loan:
1) As a replacement for aging equipment
2) In order to upgrade existing equipment that, while still functioning properly, may be becoming outmoded.
3) As an addition to a company’s present inventory of equipment
Some of the businesses that would most likely be in the market for an equipment loan include auto body shops, farming businesses, construction companies, healthcare providers, restaurants, shipping companies, manufacturers, creative agencies and IT firms, among others.
Benefits of equipment loans
Turnaround time for approval, tax deductibility and the ability to retain more capital are just some of the things that make equipment loans an attractive option for small business owners mulling financing options.
1) An application for an equipment loan is likely to meet with fairly prompt approval. Applying through an online lender may also facilitate the process. Quicker funding can mean a faster path to upgraded inventory and better equipment or machinery to make one’s business run smoothly.
2) The monthly payments on an equipment loan may be deductible as an operating expense. To know for certain, loan applicants are best advised to check with not only the lender, but with a tax attorney.
3) A small business obviously needs liquid funds for plenty of other purposes besides buying new equipment, and an equipment loan can benefit them by enabling them to have more cash on hand. Not all expenses are planned for, and having extra cash on hand could be vital if an unforeseen expense such as a repair comes up. Equipment loans can be used to replace or repair items the company needs to keep operating.
4) Payment schedules may be more flexible with equipment loans. Depending on the lender, there may be an option to select from paying monthly, quarterly, biannually or annually. Such flexibility could be a godsend for a business needing to function normally while still paying off its loan on business equipment.
Whether a company’s equipment is malfunctioning and the need to replace it is imperative, or current equipment is still functioning properly but is beginning to become outdated, an equipment loan can help keep a business competitive by having equipment that is closer to state of the art level.
If equipment is beginning to malfunction, a business owner may be weighing the cost of simply getting the present equipment repaired against the prospect of purchasing a replacement. Sometimes your auto mechanic may break it to you that the cost of repairs your aging vehicle needs is so prohibitive that you’re better off just replacing it with a new vehicle. The same principle applies to businesses and their equipment. A loan for new equipment may figure to be more sustainable than a steady stream of repair work to the same old equipment.
Another benefit of equipment loans is that the lender assumes less risk than with some other types of financing. The collateral for an equipment loan is the equipment being purchased with the borrowed funds, so if the business owner ends up defaulting, the lender can just take the equipment as collateral and sell it off to recoup the balance on the loan.
What also makes an equipment finance agreement a viable option for many is that it can be used as a tax write-off. New equipment purchases can usually be deducted as a business expense.
Preservation of working capital is an important consideration, especially in a case where the spend on new equipment might be prohibitive. Financing new equipment for a business makes sense if it will help keep the company’s checking account flush with enough funding to cover payroll, monthly expenses and even any marketing the business may be undertaking.
As many as 60 percent of small businesses are faced with cash-flow issues whether the reason is customers who don’t pay on time, the amount of cash going toward inventory or low profit margins.
How to get approval for an equipment loan
Getting approved for an equipment finance agreement will hinge on several variables. Among the most critical are:
1) How much business experience you have
2) What sector the business is in: A higher-risk sector such as construction will make approval more challenging and the standards for approval more stringent.
3) The profit and cash flow position of the company
4) The type of equipment being financed (Is the purchase standard equipment or something more specialized?)
5) The company’s Interest Coverage Ratio: ICR gauges the ability of a business to meet its interest payments.
A company’s chances of qualifying for equipment business loans will be greatly enhanced by a positive business credit history. Late credit card payments or any prior cases of defaulting on a loan are going to be held against an entrepreneur seeking equipment loans for business. A loan applicant should find out his FICO score and be cognizant of her credit history. These things can be found at www.fico.com.
A business owner who comes to a prospective lender armed with a clear and well-organized business plan will boost his or her chances of getting approved. It should include a description of the business, its cash-flow system and its projected level of growth. It will help, as well, to have cash-flow statements in hand.
The loan amount a business is seeking, and what type of equipment is being financed will help determine the identity of the lender a company goes to for funding. Some equipment loan providers are much more likely to approve a large loan. Some lenders might be willing to finance millions, while others might only be comfortable going up to $100,000 on the size of a loan.
Once the bank (or lender) has determined the amount it is willing to finance, terms will be addressed. The length of an equipment loan can range from one to seven years, depending on the type and value of the equipment. The Annual Percentage Rate (APR) – or the amount of interest you pay – can depend on the size of the loan, the type of equipment, and your company’s credit standing. In most cases, the longer the loan term, the lower the APR, and vice versa.
What is an SBA Loan?
The Small Business Administration (SBA) has a loan program with the purpose of making access to capital more attainable to business owners. Featuring low down payments and interest rates that are below market rate, the SBA 504 Loan Program allows small and medium-sized businesses to invest in their facilities and expand their reach, giving them more stake in their community. The SBA 504 program was developed with the intent of aiding small businesses in the creation of wealth.
With an SBA loan for equipment, the SBA federally backs the loans, reducing their risk to lenders, and also making it easier for a business to secure a loan with lower interest rates. An SBA loan can assist in a company improving existing facilities, purchasing machinery and equipment, or buying commercial real estate.
But, be warned, the requirements for qualifying for a small business loan from the SBA are stringent, and the wait for approval could be a long one.
Risks of equipment loans
A business that applies for an equipment loan is running a risk even before the loan is either approved or rejected. Any lender is going to run a credit check on a company seeking a sizable amount of financing. A hard credit pull is when a potential lender reviews someone’s credit as part of the approval process.
Credit checks like these can eventually have a negative impact on an individual’s credit score if there are too many of them. A business might seek an equipment loan today for something the firm needs now, but, a year from now, the need for more equipment or a different piece of equipment might entail seeking another loan–and eliciting another hard credit pull. Too many of these hard credit pulls could be viewed as a red flag by some prospective future lenders.
For most people, one hard inquiry will cause your score to drop less than five points, according to FICO. If you have excellent credit, you may not see any negative effect from a hard inquiry.
Ironically, another risk in financing equipment for a business is that a lender might discourage the borrower from paying off the full balance of the loan early–even if the business ends up thriving and being able to afford an early payoff. Despite that, some lenders might build certain penalties into the process of paying a loan off before it’s due.
The new equipment that a business purchases with its loan could also run the risk of quickly becoming outmoded by the newest, latest, greatest innovation–which might have been the impetus for buying THIS piece of equipment in the first place.
Leasing equipment instead of buying it with a loan
When you lease equipment, you usually do not need to have a down payment. For a company that lacks the capital to lay such funds out, this is one aspect of leasing business equipment that can be quite attractive.
Just as is the case with leasing a vehicle, equipment leasing entails paying a monthly fee and then, when the full term of the lease is up, either returning the equipment or buying it outright for fair market value. The lessee is also liable for any damage that the equipment might encounter, so there could be an additional charge to repair that damage in addition to the lease fee.
Leasing business equipment could end up costing a lot more in the long run than buying the equipment up front. But a business in a stage of rapid expansion or one in a sector where equipment turnover is frequent might still be better off going with a lease rather than seeking financing for its equipment.
An attractive aspect of an equipment lease is that the monthly rate one is paying is likely to be less than monthly financing charges. Without having to make a huge down payment, and minus an exorbitant monthly charge, a business should be left with more cash on hand for expenses such as payroll, bills and new inventory.