Lease companies have very streamlined appication processes that are designed to require very basic information for smaller ticket deals, with information requirements increasing with lease request complexity. As an example, for amounts requested under $25,000, the application can be completed in just a few minutes and an approval received in as little as an hour via electronic scoring systems specifically designed for speed. With higher value requests, more information will be required with approvals being issued in one to 3 business days in most cases. Compared to an equipment loan process that tends to require the same amount of information and time process an application, the leasing process is noticeably faster.
One of the reasons for the faster process is due to the demand by customer to have a faster process in order to take advantage of opportunities to purchase equipment when items come available and to reduce business down time when replacements are required. Another reason lies in the fact that the leasing company ends up owning the underlying security and they will also only focus on equipment they feel comfortable liquidating, allowing for a quicker assessment of any financing request.
Cash tends to be a precious commodity in any business, and the ability to create a higher level of financial leverage at reasonable costs is important to manage cash flow and acquire the necessary assets to run the business. For equipment leasing, leverage or the percentage of the asset value that can be financed, is as high as 100% in most cases. In cases where delivery, installation, and training costs are involved with the asset purchase, these related soft costs can be financed by the lease as well, effectively providing greater than 100% financing.
And by being able to access lease financing, a business can keep their line of credit and cash supply available for working capital and other requirements.
An approved equipment lease will be repaid through an amortized payment schedule that remains fixed during the entire lease period. The lease term can also be matched to the timing of the real depreciation of the equipment so that you’re only paying for the value being consumed versus paying for equity in the equipment that can’t be expensed until much later into the future. As a result, the lessee can more accurately manage cash flow and project future cash flow requirements including when asset replacements or upgrades will need to be made.
When you purchase an asset for cash, you are required to pay all the point of sale taxes at that time. With equipment leasing, the lease company is the one purchasing the asset, so they pay the taxes at the point of sale and the lessee only pays taxes on each lease payment as they come due. This creates a deferment of taxes which reduces the amount of cash outlay that is required at time of purchase.
Operating leases and capital leases have different accounting both for the business financial statement and income tax planning. Based on the nature of the business, there can be advantages to considering different types of leasing programs to get the most tax and accounting benefits. For instance, a capital lease is treated more like an equipment loan for accounting and taxation purposes, while an operating lease can allow for 100% of the lease payment to be classified as an operating expense.
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.
Commercial Equipment Leasing products can cover many different types of asset types that are utilized by going concern businesses.
A commercial equipment lease, or business equipment lease can finance asset purchases of as low as $1,000 in some cases to several million dollars in cost.
The key difference between consumer equipment leasing and leases for commercial equipment is the variety of assets that are considered for financing.
Every industry has its own equipment usage needs and the related cost need to be financed by some combination of cash, loans, or leases. For commercial leasing to be available for an asset type, the asset needs to have both significant sales in the market on an annual and ongoing basis as well as a resale and/or disposal market for used equipment.
If these conditions exist, then its very likely that a commercial leasing source will be available to business owners that wish to acquire the product.
Commercial equipment lease programs tend to be very focused on a particular slice of the market. Some companies will only consider equipment financing applications of less than $150,000 while still others will concentrate on larger sized equipment financing requirements.
Some leasing companies can be very focused on certain types of equipment while other companies can be very broad based in terms of what they will consider financing.
One thing that is for certain is the more volume and variety of an equipment type sold into the market, the more commercial equipment financing options will be available.
Commercial equipment leasing can also range in cost from bank prime plus effective lending rates to lending rates climbing into the high teens. Higher rates relate to higher risk and lenders that are prepared to provide equipment leases that are higher risk in nature typically will have a strong liquidation pathway for the equipment. What this effectively means is that the leasing company has very in depth knowledge of the equipment resale market and understands exactly how to dispose of the equipment that is financed and what is the likely sale value they can receive under a forced liquidation scenario.
The higher risk lenders tend to be vertically integrated with equipment resellers and auction services that provide the means for disposing of equipment in the event that a lessee defaults on the lease and a collection action needs to be undertaken.
While low risk commercial equipment leasing companies have the same concerns when it comes to managing risk, their focus is more on the financial strength of the overall business and the business owners.
Equipment leases under $25,000 are approved in a similar fashion to consumer financing whereby the decision to approve a lease application is largely based on credit history and stated income. As the the amount of lease financing requested increases, the more information will be required to support an approval. Once applications get into the hundreds of thousands of dollars, multiple years of accountant prepared financial statements will be required along with accounts payable and accounts receivable ledgers, customer contracts, supplier contracts, business plans, cash flow projections, and anything else that would support the case for financing.
And like consumer lease financing, business equipment leasing can cover off 100% of the asset cost, making it a highly leveraged and cash flow friendly form of financing.
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.