Equipment Loans continue to be a strong financing option for both new and used equipment for more established businesses with good credit or small businesses that qualify for government supported loan programs.
In Canada, for instance, the small business financing program sponsored by the federal government, can provide financing on equipment of up to $250,000 for qualifying businesses.
In general, outside of government support programs, equipment loan programs are more focused on what we’ll call stronger than average borrower credit profiles as compared to leasing companies which collectively cover off a lot broader range of credit and lending risk with respect to equipment based assets.
The key reason for stronger borrower requirements among lenders is due to the fact that the financing company does not own the underlying asset and will be more challenged to realize on its security in the event that the borrower does not meet all the conditions of financing.
Equipment loans are secured by the underlying asset, but the credit decisions are also largely based on the overall financial stability of the business, existing credit rating, and strength of ownership.
For businesses that have solid credit, equipment financing through debt instruments can provide for some of the lowest financing costs available. This is due to the fact that the providers or equipment loans are traditional banks and other lending institutions that have access to very low cost capital. If you qualify for their equipment lending programs, you can receive great effective interest rates.
Leasing companies can also provide similar implicit borrowing costs, but it will also depend on their source of financing. The majority of leasing companies do not have similar sources of financing, so their best offering will not likely be able to beat a bank rate.
At the same time, leasing companies cater to a much broader spectrum of credit than equipment lenders. For credit that is not well developed or strained in any way, equipment leasing options can be the best fit.
The key here is what the business is eligible for. If you can qualify for an equipment loan, its definitely something to consider due to the potential lower cost of financing.
While equipment debt financing will not always be the best deal, it will provide you with other options to consider.
Depending on the country you live in and the related tax jurisdiction, the definition of operating and capital leases can vary for accounting and income tax purposes.
In Canada, an overview of the related definitions are as follows (check with your accountant for a more detailed review of the rules and related interpretations).
For a capital lease, the equipment is expected to be financed for most of its useful life and there is a reasonable expectation in place that the lessee will purchase the equipment outright from the lessor at the end of the lease term.
An operating lease is basically the opposite in that the equipment is leased for less of the useful life of the asset and at the end of the lease term, the lessee can return the asset to the lessor with no further obligation.
From an accounting point of view, the assessment of capital versus operating lease is done by applying the following four rules to a leasing transaction. If any of these four rules apply, the underlying lease is a capital lease.
First, does the lease term represent more than 75% of the equipments projected useful life?
Second, does the lease provide the lessee with an option to purchase the equipment at an amount less than its fair market value?
Third, will the ownership of the equipment be transferred to the lessee at the expiration of the lease term?
Fourth, is the net present value of all the lease payments greater than 90% of the fair market value of the equipment?
If the answer to all of the four questions is NO, then the lease is an operating lease.
A capital lease ends up being accounted for on your financial statements much like an asset purchase in that the leased item has to be set up as an asset and depreciated over time while the lease needs to be shown as a liability with the interest portion recorded as an expense for tax purposes.
Operating leases are not listed on the balance sheet (they may be listed in the notes) and the related payments are recorded as an operating expense.
Unless the business has no intended future use for an asset after the financing period, the resulting financing tends to be in the form of a capital lease.
Capital leases also tend to be lower in what we’ll call the net effective costs associated with the lease as there is no risk premium built in by the lessor for asset disposition at the end of the lease term.
Operating leases are more suited to assets that either wear out quickly from heavy use or are rapidly replaced in the market by newer technology.
Small business equipment leasing options are available for just about any type of equipment with a value of at least $1,500.
Equipment leasing programs tend to be categorized according to time in business (start up, less than 2 years, greater than 2 years), amount of financing (up to $100,000 is small ticket, and over that is large ticket), and credit profile of the borrower.
For start up financing requests, there typically will be lending limits of anywhere from $25,000 to $50,000. Start up financing applications are largely assessed on personal factors of the borrower due to the lack of business history.
Even when companies are under two years in business, the credit assessment is still largely personal in nature for the smaller financing amounts. The only real difference compared with a start up application is that lease companies will tend to consider large amounts.
Once a company is more than two years in business, has two years of financial statements under its belt, and has had the chance to establish some business credit, an equipment financing application is more highly weighted toward business related factors.
Small business equipment leasing can be very specific in nature to the type of equipment as well as geography and credit history.
There are leasing companies that are also very broad based in terms of the types of assets they will cover, although they will also tend to have an asset rating system that will indicate the types of assets they prefer to finance versus ones that are considered to be more risky. The more risk associated with an asset type, the harder it typically will be to secure financing, and when financing is secured, the terms and conditions will likely be tighter. For instance, a sizable down payment could be required, or an additional guarantor, or higher interest rates and shorter lease terms may become part of the lease commitment offer.
Small business equipment leasing typically requires a personal guarantee from one or more individuals whereby the guarantor is expected to have solid credit and a net worth and/or annual cash flow capable of covering off the lease obligations in the event that the small business holding the lease does not make all its payments or honor all the terms and conditions of the lease.
Lease financing companies can also be very niche focused, only focusing on asset types that they know how to liquidate in the event of default. Sometimes these companies are vertically integrated with equipment liquidators so that they can more accurately assess the recovery value of an asset and to also allow them to participate in financing used equipment in their niche. One of the main requirements for this type of lender is the presence of a large and active resale market for the assets they focus on.
For small business equipment financing applications under $25,000, lease approvals can be received in a matter of hours with very limited application information required. As the amount of financing required goes up, so does the amount of information requested in the application and the time required to process and render an approval or decline (1 ot 3 days).
The large majority of equipment financing approvals do not require any down payments and can provide lease terms of 5 years or greater in some instances.
To understand how to take advantage of small business equipment leasing, contact an equipment leasing and financing specialist and get all your questions answered before signing up for any lease financing program.