Equipment financing is when you obtain a loan to purchase equipment. However, equipment financing can also include equipment refinancing, which can result in reduced monthly payments or cash out (working capital). And whether you are financing the purchase of a new or used machine, or refinancing, the process is similar.
Many small to medium sized businesses use equipment in their daily operations. Many of these companies don't have enough money in the bank to pay cash for the equipment. And even if they have enough cash, it's always wise to have some readily available funds for emergencies or opportunities and not tied up in a long term asset.
How does equipment financing work? In a nutshell, equipment financing works like this:
- The buyer identifies the specific equipment it needs to purchase.
- They negotiate the equipment specifications, price, accessories and delivery terms with the equipment seller.
- The buyer provides information about the equipment and their business, including a credit application and other supporting documentation (referred to as the credit package), to the potential lender.
- The lender evaluates the credit package and determines if they will offer loan terms to the company (now the borrower). The lender provides the borrower with the terms of the loan (down payment amount, interest rate, length of loan term, monthly payments).
- The borrower decides if they want to accept the terms of the loan.
- Once the borrower accepts the loan terms, the lender prepares the paperwork to be signed by all parties.
- The lender files a lien against the equipment, and the equipment serves as collateral on the loan
- Once the paperwork has been signed and fully executed and the equipment is ready for delivery, the lender releases the funds to the equipment seller.
- The borrower/buyer takes possession of the equipment.
- The borrower/buyer pays the lender the agreed upon payments.
- Once the borrower has paid the lender in full, the lender then releases the lien and the borrower/buyer owns the equipment outright (otherwise referred to as free and clear).
Pros and Cons of Equipment Loans
As you try to determine if you should take out a loan to purchase your new (or new to you) equipment for your business, consider a few benefits and drawbacks.
Benefits of Equipment Financing
- If you don't have enough cash saved to make the purchase, a loan will allow you to get the equipment you need, sooner than having to save for it
- If you have cash saved, an equipment loan conserves that cash so you can save it for use elsewhere (in case of emergency, or for other opportunities)
- An equipment loan will help build business credit (provided you make payments on time)
- Is often more affordable than other financing options, such as angel investors, or merchant cash advances
- As you pay down the loan, you build equity in the equipment, which can be used later to obtain working capital (compared to renting or leasing the equipment)
Drawbacks of Equipment Financing
- You will pay interest on the loan, so the overall cost will be more than if you had paid cash
- If you default on the loan (don't make the agreed upon payments), you will damage your business credit, making it more difficult to obtain another loan
- You do own the equipment (title is in your name, you are responsible for insurance and maintenance), but don’t own it free and clear (unencumbered by a lien) until payments have been made in full
Choosing an Equipment Financing Partner
One of the most critical selection criteria should be how well your lender knows the type of equipment you are financing. When you work with a lender that has experience financing the type of equipment you are purchasing, you can count on them to facilitate a seamless process. They know the equipment, can often help you determine if you are getting a good price from the seller (especially if you are buying used equipment), and they can structure a loan that makes the most sense for your business and your industry.
For example, if you are purchasing heavy construction equipment, you should seek out a lender that has expertise in heavy construction equipment. You wouldn't buy construction equipment from a restaurant equipment dealer, so why would you finance an excavator with a lender that specializes in financing restaurant equipment?
Especially if you have a young business, a lender with industry and equipment expertise can be invaluable. They can help guide you to ask the right questions of the seller, help determine if you are getting a good value for your money, and most importantly, structure a transaction with a payment schedule that works for you.
Want to explore your equipment financing options for construction, manufacturing, transportation, or waste equipment? Let us help you evaluate your situation, review the equipment you want to purchase, and structure a loan that works for you, your cash flow and your business.