Understanding Equipment Financing and Loans
Equipment loans are loan options designed to help businesses buy, repair, replace, or upgrade business equipment. This can cover everything from medical and dental equipment, ovens for a restaurant, heavy equipment for manufacturers, tractors, large commercial vehicles, computers and phone systems. Equipment loans are specialized financing options for small business owners that can often reduce monthly payments and preserve working capital.
Every lender will have their own policies and terms, but loan amounts usually will be issued to finance around 80% of the cost of a piece of equipment, with most requiring a down payment to cover the rest. This means that fees, additional taxes or delivery charges must be handled by the buyer. Much like financing a car, you actually own the equipment from day one, using that item as collateral for the loan. Banks will sometimes have limitations on the types of equipment they will issue loans for, especially if there is a question of the collateral type and long-term value.
Depending on the credit of the borrower, a bank may require additional collateral beyond the equipment itself, which could be anything from other equipment to accounts receivable for that business. Banks issue equipment loans with a well-defined loan term, meaning the payments are spread over a set period of time.
Equipment loans are generally issued by banks, but many online lenders and equipment manufacturers are now competing in this space as well. Eligibility to qualify for an equipment loan are similar to other business loans:
- Credit score
- Time in business
- Annual revenue
- Cash Reserves
- Business plan
Loans have both positive and negative aspects that a business will have to consider before signing on the dotted line.
Major Advantages of Equipment Loans
- Buyer owns the equipment from the start of the loan
- One loan can cover multiple pieces of equipment
- Helps buyer build credit
- Structured payments
- Increase business asset book value
- Some payments or interest may be tax deductible
Major Disadvantages of Equipment Loans
- Cannot receive 100% of the value of equipment through loan
- Down payment required
- Interest and fees are included in every loan
- Buyer owns the risk of inflation and equipment depreciation
How to Prepare for an Equipment Loan Application
Make Sure Personal Credit is in Order
Lenders look at the business owner’s credit along with everything else. Small business lenders rely on many factors to make a loan decision, probably none more important than the credit history of the people running the business. If there are past loans that entered collections or were defaulted on, getting a good rate on a loan – or a loan at all will be difficult. Make sure that you are well aware of your FICO score and credit history, and come to a loan meeting prepared to negotiate with that information. Spend time to ensure your credit report is accurate well in advance of applying to safeguard you have everything in order. Preparation is the key to making sure you get the loan you need at the rate you want.
- Write or Polish Up Your Business Plan
Banks and lenders want to be sure that they are lending to a business that has demonstrated success and that has a plan to continue building and growing that growth. Identify and target your desired market by conducting or studying market research and demonstrate an understanding of the demographics and economic states of the customers or clients you plan on serving. Make sure you have a solid grasp of the industry where your business resides, with at least a basic analysis of the competition and how you plan on managing your business against theirs. You do not have to write a lengthy volume to make an impact, but you should be able to directly and accurately describe your business to anyone that asks, both verbally and in writing.
- Update Business Records
Beyond personal information a lender’s credit analysts will be reviewing your business records, including credit information, tax returns, profit and loss statements, balance sheets, and a list of current debts and assets. Before submitting an application or proposal for financing, ensure that you not only have all required records, but that they are accurate and complete. At least three years of federal tax returns will be required for the application process, as well as three years of financial records from your business operations. Be prepared to explain or detail any existing debts, as well as an overview of your repayment terms with other lenders. Do not inflate or pass over existing assets, as they may be included as collateral for any loans you receive.
- Determine Where to Apply
Banks and alternative lenders are varied in their rates, lending ability, and flexibility. Picking the right lender for your situation is as important as having all your other information in place. There are a few options for equipment loans:
- Commercial and Traditional Banks
- Nonbank Lenders
- Region- and Industry-Specific Lenders
Business Equipment Financing Sources
Traditional banks come in different shapes and sizes, and usually offer a familiar suite of business loan products. Businesses’ loan applications are subject to full credit and financial analysis, as banks are governed and regulated by national and sometimes international authorities. Because of this regulation, a bank may be more conservative with their lending dollars than an alternative lender, as banks are often more careful not to skew their balance sheet one way or the other with risky loans or a portfolio too heavily concentrated in one industry or another.
The size and type of bank will also impact their ability and willingness to issue loans of various sizes and types. Publicly traded banks and large regional community banks are sometimes in a better position to issue large business loans, and may have partnerships with equipment manufacturers to deliver special rates and terms. Another option, which may offer more varied and attractive loan packages, are commercial-only banks whose primary function is to serve businesses and their banking needs.
Banks are also primary issuers of SBA loans and issue the majority of small business loans under the SBA 7(a) program.
An SBA loan is great if you can get it but borrowers with bad credit are not likely to qualify for an SBA loan.
These entities, sometimes known as alternative lenders, can be anything from a mortgage company to an online lender like Biz2Credit. Because these financial institutions do not offer a traditional suite of banking products, they can be more flexible in their loan offerings, many times assessing clients’ needs on a case by case basis to deliver a custom solution. Their status as nonbanks also means that they are not subject to the same regulatory scrutiny on their balance sheets. This does not mean that they aren’t legitimate, but may suggest that they are more apt to focus on an applicant’s potential and savvy as a business owner, rather than concentrating entirely on credit history and personal finance.
Regional and Industry-Specific Lenders
Sometimes including rather traditional banks, these lenders have been set up with a specific focus on an industry or area. Many times, a government in an area will determine a need to develop the economy or land within their jurisdiction. If the public sector is well-developed in that region, there may be an office set up within the government to offer loans or grants that deliver funds to their desired focus, but in other cases a traditional lender may be approached to offer these services in exchange for subsidies and incentives to produce loans that support the development goals. This means that businesses meeting the criteria of the development goals may qualify for heavy subsidies, special discounts, and sometimes even deferred or zero-interest loans to grow their operations in support of the program.
Alternatives to Equipment Loans
In some cases, a loan may not be the best option to obtain or update existing equipment. There are a variety of other financing services that can help your business grow.
Equipment leases are very similar to loans, in that there are installment payments and the funds are obtained up front. There are several options in this space alone, with specialized leasing companies that do nothing else and can offer a great range of products to meet business needs. The equipment manufacturers will also offer some sort of leasing programs in most cases, with potential incentives and discounts to use their financing over a bank or other entity.
Leases differ from loans in a few key areas:
- Equipment leases are usually issued to cover the entire cost of a piece of equipment plus fees and other charges, sometimes called “soft costs”. This means that leases do not require down payments and can be less impactful on up-front costs than a loan. The pressure on a business owner is less severe when there is no down payment involved.
- Unlike taking out a loan to purchase equipment, using a lease means that you are essentially renting that equipment for the duration of term of the lease. You do not own the equipment up front like with a loan, but will usually have the option to purchase the equipment after the term is complete for what is known as residual value – usually a fraction of the original MSRP of the equipment.
- Maintenance and usage guidelines are at the discretion of the leasing company or bank. Because they technically own the equipment, they are in control of that item for the duration of the lease. This can make it difficult to obtain service or move the equipment from location to location without prior approval from the financing entity.
Crowdfunding and Microlenders
If you are unable to obtain financing through traditional channels or do not want to be tied to a financial institution for your funding needs, there are alternative channels that have been created to address these concerns.
These services have become very popular in recent years, as the rise of social media has made it easy to create and share ideas. Sites like Kickstarter and GoFundMe have grown tremendously to offer a platform where business owners, entrepreneurs, and creators of all types can offer their products and services to the world in return for what basically equates to donations. The people donating generally receive a reward for giving, sometimes in the form of a sample of the businesses’ products or other acknowledgment of their donation. These services are great for testing public opinion on a new idea and for generating solid interest in a business, but should be viewed as specialty financing that cannot replace traditional lending or leasing for equipment. Because of the platforms’ need to fund themselves, they sometimes take high percentages in fees and marketing costs, and there may be a restrictive requirement on how much money is raised in relation to the campaign’s stated goals. In specific cases, these options can be very helpful, but view them carefully against traditional financing options.
If you are not able to obtain a loan and don’t want the hassle of a crowdfunding campaign, microloans may be an option of last resort to finance your equipment needs. These loans are made peer-to-peer, meaning someone else is lending you money directly. Sometimes set up to help business owners in developing countries, these types of loans are also becoming popular in other parts of the world for people that have bad or little credit histories. Because they are set between two private parties, the terms and rates associated with the loans can sometimes be very difficult to understand or outright dangerous, as the lender sets their terms without any oversight. There are a variety of sites and platforms that offer the ability to both lend and borrow in this format, but they should be viewed as an absolute last resort. Unless you are able to find a lender that can offer terms that are favorable or comparable to a bank or leasing company, you may end up spending thousands more in fees and interest than you would through traditional channels.