As a small business owner, there’s too much on your table, from planning and strategy, to manage financials, operations, sales, and resource management. When your business operations are equipment dependent, constant upgrades and replacement are crucial to your growth and effective operations. However, buying new or pre-owned equipment or simply upgrading them requires a financial decision. You’ll have to decide whether to finance the equipment or lease it to keep cash flow stable.
Irrespective of your decision to choose the option, financing, and leasing will get you the essentials tools, machinery, vehicles or other equipment you need to keep your business operations functioning successfully. While considering equipment financing or equipment leasing, let’s explore these options to understand which is right for your small business.
The Difference between Equipment Financing vs. Leasing
The major difference between these two options is ownership. With equipment financing, you purchase the equipment with a loan and after repaying the loan, you own the equipment. Equipment financing is a collateralized loan where the equipment acts as collateral for the loan.
With an equipment lease, the vendor provides you the equipment for use at a monthly payment, but you don’t own the equipment during the lease term.
Equipment Financing: The Details
When you decide to purchase or finance the equipment, equipment business loans are a great option. This option is more suitable when you plan to use the equipment for a longer-term and don’t require to update equipment regularly. In equipment financing, you own the equipment after repaying the loan, just as you do with a home mortgage.
Some recent changes in the depreciation rules have made equipment financing more beneficial to some companies rather than equipment leasing. According to Section 179 of tax law, now small businesses can deduct 100% of the equipment purchase expense (up to $1,000,000) during the year of purchase.
This rule was made to encourage small business economic activity by making new equipment more accessible. If the equipment cost exceeds $2,500,000, the deduction starts to decline, which highlights the value of these rules particularly for small business owners.
Every small business owner can benefit from this rule – meaning if you’re short on cash, you can use equipment business loans to obtain the capital, and then deduct all or most of the loan from your taxes that year. This makes it a win-win arrangement for small business owners where you not only get the equipment but can also deduct the loan expense in the process. Keep in mind that, there is the exception to this rule, and when you intend to make a purchase, make sure it’s tax-deductible.
Equipment financing is the best option to purchase equipment that has longer retention value such as trucks, construction machinery, and furniture. Once you’re approved for an equipment loan, the lender will provide you upfront cash up to purchase the equipment. You’ll repay the loan over a predetermined period plus interest. The equipment loan term generally depends on how long your lender expects that the equipment will be valuable. After you repay the loan, you’ll fully own the equipment.
Pros of Equipment Financing
Equipment loans have easier qualification than traditional loans; even less-than-stellar credit borrowers can get approval. Because the equipment itself acts as collateral for the loan—if you default on your loan payments, the lender can seize the equipment and sell it to recoup their loan.
Because of this inherent collateral, it lowers the lender’s risk of losing the money in case you default. For that reason, lenders offer easier qualification and quick approvals and are less concerned with your credit score, annual revenue, and business history during the reviewing process.
Lower Interest Rate
The important consideration for lenders while financing your equipment is the equipment condition and resale value. If the equipment condition is good with the higher resale value, they will offer a lower interest rate. The amount of money a lender will be willing to lend you is determined by the equipment’s resale value.
- No Collateral Requirement
Equipment loans are collateralized loans where the equipment acts as collateral for the loan and you don’t have to provide any valuable assets to secure the loan.
- Relatively Low Cost
Another benefit of using equipment financing is the lower cost of the loan. The interest rate on an equipment loan can be as low as 7%, and as high as 30%. Even at the higher end, the cost is lower than the interest rates charged on business term loans. Additionally, the long-term cost of equipment loans is relatively lower than an equipment lease.
Cons of Equipment Financing
- Down Payment Requirement
When you’re approved for an equipment loan, the lenders typically provide upfront cash up to 80% of the equipment value, and you’ve to pay for the remainder upfront.
- You’re Stuck with the Equipment
Before purchasing equipment, make sure it retains its value until the end of your loan’s terms. Else, you’ll be stuck with the outdated equipment that might need replacement.
- Repairs are Your Responsibility
In equipment financing, you’re fully responsible for the equipment in case it breaks down or needs a repair.
Equipment Leasing: The Details
Leasing business equipment comes handy when you don’t have the capital to purchase new equipment outright or they don’t want to experience cash flow problems. In equipment leasing, you get the equipment at rent from the vendor at monthly payments. When the lease term ends, you can either renew it or purchase the equipment outright.
Equipment leasing works best for a business that regularly updates its equipment because leasing allows you to keep your cash reserves and pay less while getting new, updated equipment for your small business.
Internal Revenue Service (IRS) states that lease payments are 100% deductible with no limit, while interest on loans is now the only deductible up to 30% of earnings for businesses with revenue more than $25 million. If your business revenue is more than $25 million and you’ve deducted 100% of interest payments conventionally, you should now consider leasing instead of paying more in the taxes.
Every lease agreement has its own features and requirements, and it’s crucial to carefully review the terms before you put the signature on. Due to every agreement’s uniqueness, you don’t know exactly how it can affect your business until you glance at the lease terms.
Usually, equipment-leasing agreements are for two to seven years terms, but they will not outlive the equipment’s value.
Pros of Equipment Leasing
- No Collateral or Down Payment Requirement
Equipment leasing doesn’t require any collateral or down payment –allowing you to use your cash reserve for your other business’s expenses and growth.
- Simple Application Process
The application process for equipment leasing is very simple – there is no requirement of extensive paperwork and financing is available for poor credit borrowers as well.
- Lessor is Responsible for the Repairs
In equipment leasing, the leasing company is responsible for the break down or repairs. Whereas in equipment financing, you’re liable for the repairs or breakdown.
- Flexible Terms
Most lease agreements provide flexible lease terms after the lease ends. You can choose to either purchase the equipment outright, renew the lease, return the equipment or exchange your current equipment for new or updated equipment with a new lease.
Cons of Equipment Leasing
- You don’t Own the Equipment
The major drawback of equipment leasing is that you don’t own the equipment on which you count on. You can’t sell it to recoup your upfront costs. Moreover, it’s not an actual asset on your balance sheet items.
- High Pricing
In equipment leasing, you don’t pay interest on your monthly payments. However, some lenders add interest rates into flat monthly payments; this is how they typically make money off their deals. The price of your equipment leasing based on your personal credit score, annual revenue, and time in business. Most lenders determine the price depends on the equipment value they’re buying and the lease term.
- You’re Paying More Over the Lease Term
Based on the high price charged by a leasing company, you might end up paying a lot more over the lease term than you pay if you had taken out an equipment loan.
- Lease Dictates the Equipment Usage
Most lease agreements dictate how you can use the equipment, such as to keep it in good shape, performing maintenance on schedule, and keep the usage under a certain threshold. Additionally, violating the terms of usage can lead to substantial financial penalties.
The Bottom Line
While choosing financing or leasing for your business equipment needs, review the details carefully. Evaluate what type of equipment your business needs to grow, and determine the financial impact of that specific equipment if you choose to take out an equipment loan vs leasing. When you really need new or pre-owned equipment or an upgrade to avoid interruptions in your small business, it’s likely the time to explore these loan options. No matter which option you choose, having a new or updated equipment will position your small business for steady growth.