When you’re looking into financing your new startup, you don’t always need a lot of working capital or cash, but you might need an expensive piece of equipment or two. A restaurant can’t get off the ground without some commercial kitchen appliances, and even a mom-and-pop lawn care company needs at least a mower and weed eater. Equipment financing is one way to ensure you have access to the resources required to launch your new company.
What Is Equipment Financing?
Equipment financing involves a loan or lease that is used to fund the purchase of or use of equipment for your business. Unlike with general business loans, which can be used for a variety of purposes, you can only use the funds secured via an equipment loan for the equipment approved by the lender.
This limitation is because the equipment is typically used as collateral for the loan. It works a lot like a traditional auto loan. The lender provides the money to purchase the equipment at agreed up terms — typically involving a monthly payment. If you don’t make the monthly payments, the lender can repossess and sell the equipment to recover some of its losses.
To qualify for an equipment loan or lease, you must be purchasing or leasing equipment specifically for use in making products or providing services within your business.
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Reasons to Seek Equipment Financing
You might think it would be better just to pay cash for equipment for your company; that way, you don’t start your new business with debt. And while that seems like great logic on the surface, depending on how much cash you actually have on hand, trying to avoid equipment financing completely could put your new business at risk.
Here are a few reasons you might seek equipment financing for your startup.
- You simply don’t have the cash to purchase the equipment. Some equipment necessary for your business can be quite pricey — as much as thousands or even tens of thousands of dollars. Most startups don’t begin with that kind of extra capital lying around, so you’ll have to borrow it from somewhere.
- You do have the cash, but want to hold it in reserve. Running yourself out of all the cash you have to purchase equipment doesn’t leave you anything for a rainy day, and statistics are pretty clear that new businesses have their share of rainy seasons. Using an equipment loan to buffer the cost of necessary machinery helps you keep cash on hand to manage the business, which boosts your chances of success.
- You have enough cash to purchase basic equipment, but you want premium or more capable machinery. The bottom model isn’t always the best choice for your business, even if it’s the cheapest, and equipment startup business loans might let you make the most appropriate investment in your products and processes.
Types of Equipment Financing
Equipment financing comes in two broad categories: purchases and leases. They both work very similar to how loans and leases work in the auto industry.
Equipment purchase loans typically require you to agree to payment terms, including the length of the loan, the amount to be paid monthly and an interest rate. At the end of the loan period, if you’ve fulfilled all your payment obligations, you own the equipment. This is a good option if you want to own the equipment outright, want to purchase used equipment or want to purchase and modify equipment (and therefore, need to own it).
Equipment leases typically require you to agree to a lease payment amount and time. You possess and can use the equipment as long as you make the agreed-upon lease payment. Depending on the terms of your lease, maintenance and other perks may be included. Once the lease term is up, you typically have the option of ending the lease, continuing the lease or leasing a new model. This is a good option if you don’t want to own the equipment long-term, know you’ll need to upgrade equipment every few years or can’t get approval for a loan.
Benefits of Equipment Financing
Equipment financing is sometimes easier to obtain than other types of business funding, including SBA-backed loans or angel investing. That’s because equipment financing is less risky for the lender since the equipment acts as collateral. For the same reason, equipment financing, like truck loans for example, may come with better rates and terms than other types of small business loans.
Another benefit of equipment financing is how many options you might have. Several lenders work exclusively with this type of loan, but you could also get financing from traditional banks. Some options, such as working capital loans from firms such as Kabbage, are available if you already have a history of income for your business.
Disadvantages of Equipment Financing
Perhaps the biggest disadvantage of equipment financing — especially for a purchase — is that you might need to come up with a sizable down payment. Down payment requirements vary — whether or not one is required depends on the lender, your own credit history, the business’s credit history, the type of equipment and how much you need to finance.
If you want to finance $20,000 for equipment that’s likely to depreciate $5,000 a year, the lender is taking on fairly significant risk. If you don’t make any of the payments, they can repossess the equipment, but they may only be able to sell it for $15,000, which is a loss of $5,000. Lenders often require down payments to reduce that risk.
The Bottom Line
Equipment loans — whether you lease or purchase — are probably going to be a financial fact of life for your business if expensive machinery is required in your processes. Luckily, it’s a form of business financing that is relatively easy to get and works well with many business budgets.
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