What is equipment financing?: Here’s what small business owners need to know

What is equipment financing?
 

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Staying ahead in the small business realm often means having the latest and most efficient equipment available. This is where equipment financing comes into play. But what is equipment financing, and how can it help businesses overcome the financial barriers to acquiring the equipment they need?

Whether it’s the latest technology, company vehicles, or essential production machinery, equipment financing provides a structured way for businesses to invest in their growth.This approach not only preserves cash flow but also ensures that businesses can continue to operate and grow without being impaired by the lack of essential tools and machinery.

In this blog post, we’ll provide a brief overview of equipment financing, the difference between leases and financing, the types of equipment financing available, the pros and cons, and how you can access financing.

What is equipment financing?

Equipment financing is a type of business financing used specifically for purchasing physical assets like machinery, vehicles, or technology needed to operate and grow a business.

Equipment financing allows businesses like yours to obtain a loan specifically for purchasing business equipment. This approach facilitates the acquisition of vital operational tools—ranging from office furniture and medical equipment to heavy machinery—and preserves a company’s cash flow by spreading the cost over time.

The appeal of equipment financing is in its flexibility. This means companies don’t have to bear the burden of the entire cost upfront but can spread it out over time.

How does equipment financing work?

This type of financing allows companies to use the equipment itself as collateral for the loan. In essence, if the business fails to make the required repayments, the lender has the right to take possession of the equipment.

Additionally, borrowers may need to sign a personal guarantee, making them personally liable for the loan if the business can’t repay, thereby putting personal assets at risk.

 

Learn more about other financing options:

What are the differences between equipment leases vs. loans in financing?

When you need new equipment, you’re likely facing the question: Equipment financing or leasing? Here are some key differences.

Equipment financing

This type of financing, often offered as a loan, is particularly beneficial for acquiring assets that a business will utilize over many years, such as durable machinery that is not prone to being phased out quickly or frequent breakdowns.

By opting for an equipment loan, you can own your equipment outright after the loan is paid off, giving you the flexibility to use or sell the equipment as you see fit.

Tip: Ownership means the asset can be considered a company asset, contributing to your business’s overall value.

Equipment leasing

On the other hand, an equipment lease is a financial arrangement in which a company obtains the use of machinery, vehicles, or other equipment by paying a leasing company regular payments for a specified period of time.

This arrangement allows businesses to use essential or costly equipment without the need to purchase it outright. Equipment leasing also eliminates the need for a down payment, making it a more accessible option for businesses with limited upfront cash.

Leasing involves making monthly payments to use equipment that the financing provider purchases on behalf of the business.

While this option can offer lower monthly payments compared to financing, it’s important to note that your business will not own the equipment at the end of the lease term. This is especially something you want to keep in mind if you’re interested in owning these assets in the future.

However, leasing can be an excellent choice for equipment that quickly becomes outdated, as it allows you to upgrade to newer models at the end of the lease term without the burden of selling old equipment.

 

Types of equipment financing

So far in this article, we’ve mainly discussed equipment loans and leases. However there are a few different kinds of financing you should know about as well.

Equipment loans

To recap, these loans are specifically designed for purchasing equipment, with the purchased equipment often serving as collateral for the loan. This collateralization reduces the lender’s risk, potentially leading to lower interest rates.

Term loans

Term loans offer a straightforward approach to equipment financing. Companies receive a lump sum that can be used for a variety of purposes, including purchasing equipment. The loan is then repaid over a period.

These loans are often secured by business assets, which typically results in lower interest rates and more favorable repayment terms due to the reduced risk to lenders.

Business line of credit

A business line of credit functions similarly to credit cards but is tailored for business use, providing a set credit limit that can be used for equipment purchases. This option offers flexibility because interest is only paid on the amount drawn and funds become available again once repaid.

Small Business Administration (SBA) loans

Small Business Administration (SBA) loans provide a government-backed financing option with several subtypes to cater to various business requirements.

Some options include:

  • The 7(a) Loan program supports general working capital needs, including equipment purchases.
  • The 504 Loan specifically aims at acquiring large equipment, offering up to $5.5 million in borrowing capacity.
  • Express Loans offer a quicker approval process for loans up to $500,000.

 

The benefits of equipment financing

Now let’s look at some of the benefits of equipment financing, and what you should look out for.

Lower upfront investment costs

With equipment financing, you can spread out the payments for equipment, along with its maintenance costs, over time. This reduces your initial financial burden and frees up cash that can be used for other critical business activities.

Flexible repayment options

Equipment financing is often easier to secure than traditional loans and comes with terms that can be tailored to a business’s specific needs. This might include lower monthly payments spread over a longer period, though repayments terms will vary by lender.

Access to better equipment

Financing makes it possible to acquire advanced equipment that may be too costly to purchase outright, helping your business remain competitive and efficient.

Improved business credit

This is an opportunity to build your business’s credit score as you make payments on your loan. A positive credit history is crucial for future financial endeavors, and it impacts your business’s ability to qualify for more loans or lines of credit, negotiate terms with suppliers, and even affect insurance premiums.

What is equipment financing

What you should look out for in equipment financing

While equipment financing offers many benefits, it’s essential to consider potential downsides before you make a decision.

Your use is potentially limited

Unlike other options such as a business line of credit, equipment financing limits your spending to the purchasing or repairing of equipment. If you need more flexibility, however, you have other financing options available to you, like a working capital loan.

You might face steeper down payments for more expensive equipment

Many equipment financing agreements necessitate a down payment, which can be as high as 20% of the equipment’s cost. The upfront cost can be substantial for high-priced items, potentially making leasing a more attractive option for businesses unable to afford such an initial investment.

What you choose for equipment financing can impact how much you pay in the long term

Depending on the type of equipment financing you choose, you may incur higher costs than traditional term loans. However, businesses with excellent credit might secure better rates through term loans from banks or credit unions.

Your financing may last longer than the lifespan of your equipment

If, for example, a 5-year loan is secured for equipment that becomes obsolete or breaks down after 3 years, your business would continue to make payments on equipment it can no longer use.

Before you decide to take equipment financing, do your research on equipment you’re planning to purchase to reduce the risk of this happening.

 

Choose the best right-fit financing for your business

Still weighing your options? We’re here to help.

We’ve helped 46,000+ businesses connect with financing opportunities.

Don’t let the cost of necessary equipment hold your business back. Speak with one of our financing experts today.

Speak with a financing expert today.

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