Regardless of industry, any business needs a basic level of equipment to function. Restaurants need kitchens, offices need computers, and trades companies need tools. Naturally, each set of equipment comes with an often-hefty cost, one that businesses can’t always pay upfront.

To make up the cost, businesses may turn to equipment financing. Though this might seem like a simple, self-explanatory method of raising capital, it has some surprising depth to it. For businesses looking to quickly purchase equipment and get underway, researching equipment financing can become a confusing and time-consuming endeavour. In this article, we will break down equipment financing, how it works, and how it might be beneficial to your business.

What is equipment financing?

As it sounds, equipment financing is a form of finance dedicated to supplying businesses with the cash they need to purchase assets required to operate their business. It can be used to purchase assets outright, or fund the borrowing of important, but expensive, assets. Eligible assets range from cooking utensils or construction hand tools, to a company vehicle. The applications for equipment financing are incredibly broad, given how many physical assets exist.

As equipment financing aims to facilitate the purchase of physical assets, it functions a bit differently to some other types of finance. They fall under the umbrella of secured loans, meaning that they require physical assets to be used as security, or collateral, which are repossessed in the event of a default. In most cases, the asset you purchase with the loan acts as collateral, though you may be required to use an asset of your own in certain scenarios. While this makes it a little riskier for borrowers, the low risk it provides lenders makes equipment financing much more available in comparison to other forms of finance.

How equipment financing works

Equipment financing typically works with third parties purchasing the required equipment upon the request of a business. First, a business contacts an equipment financer and presents its shopping list. The financer will make the purchase, supplying the business with their equipment and keeping their end of the deal. The business will then pay back the debt in accordance with the terms of the contract, usually keeping the equipment once the debt is paid. In the event you default, the equipment financer will repossess what they bought for you and resell it.

Exactly how your equipment financing looks will depend on whether you take out a loan for the equipment or you lease it, which we will expand upon later, though the fundamentals are the same. You make an agreement with a lender, which purchases the equipment on your behalf on the condition you pay them back later. This tends to last somewhere within the two-to-five year range, though can be shorter or longer. Because of the nature of equipment financing, it is imperative that you do your research. You must know exactly what you want to buy, and check the trustworthiness of your chosen equipment financer. They will do the buying, meaning you need to have a very firm description of what equipment you want. This will protect you legally, but also prevents any genuine mistakes from happening as a result of miscommunication.

Equipment loaning

As aforementioned, there are two types of equipment financing – loaning and leasing. The former is when a business takes out a loan to purchase equipment. Which then acts as security for the loan itself. Should the business default, the equipment is seized and resold.

Naturally, this is the best option for a business that requires equipment for the long-term, but currently lacks the capital to make the purchase. This is due to the total repayment of the loan exceeding what you would pay when borrowing, when counting interest. A business that doesn’t care to keep the equipment long after the loan is repaid would simply be burning money. This is the main downside to equipment loaning, though hardly unexpected.

Equipment leasing

In contrast to equipment loaning, leasing is the more short-term form of equipment financing. Rather than taking out a loan to make the purchase yourself, you will instead pay a recurring fee to use the equipment owned by a third party. This option is much more flexible than equipment loaning, and often much cheaper.

As equipment leasing is a short-term solution, it isn’t fit for extended periods. Before long, equipment leasing will catch up with the higher costs of equipment loaning, amounting to a higher cost if used over the long term. If you find that the equipment makes your business operations much smoother, then you could offer to purchase the equipment outright. Most lenders offer to sell their leased equipment should a business be interested, though it isn’t guaranteed. If not, then you will return the equipment once the agreement elapses.

Purchasing equipment through equipment leasing is a bit more complex than equipment loaning. Essentially, you have three main options available. Firstly, and most simply, you lease the equipment as normal. Then pay the market value at the end of the term. This is known as a fair market value lease.

10% Option Lease

Your second option is the 10% option lease. With this, you will similarly pay a recurring fee to borrow the equipment, but pay 10% of its costs at the end of the term. This option is a kind of middle ground between an equipment lease and an equipment loan.

The final option is a capital lease. This option essentially transfers ownership of the equipment from the lender to the borrower, though is contingent on certain criteria: the length of the lease must cover at least 75% of the asset’s useful life. The value of the payments must amount to at least 90% of the asset’s fair market value, and the contract must include the option to make a bargain purchase, allowing for the purchase of an asset below fair market value. If all conditions are met, the borrower can make the purchase.

Should you use equipment financing?

Equipment financing is a circumstantial form of finance. Of course, a business must require equipment to justify using equipment financing, though how long they need it impacts the type of equipment financing that works best. For a business that requires equipment for the long-term, they benefit most from equipment loaning. However, equipment leasing is best for the short term.

Provided you do your due diligence, your business stands to benefit well from equipment financing. It allows for the use of critical equipment at short notice, and is flexible to accommodate your needs. This enables you to meet your equipment needs regardless of whether they are short-term or long-term. For a business with equipment needs, there is no better way to fulfill them.