The Essential Guide to Equipment Financing for Small Businesses
As businesses continue to recover from the 2020 pandemic, a recent survey reveals that many companies are optimistic about 2021. In fact, 67% of small business owners are confident that this year will witness a return to pre-pandemic operations and revenues.
With many lenders resuming full operations, businesses will have more financing options to fuel their recovery. Specifically, companies may find it easier to finance the equipment that streamlines their operations.
What is equipment financing?
The term “equipment financing” refers to purchasing equipment for your business, typically with a business loan. After you have repaid the amount borrowed, your company owns the equipment.
Under an equipment financing agreement, the business asset is used as collateral for the loan or lease. If the borrower or lessee defaults on the contract, the asset is seized as a result. This arrangement differs from working capital financing, where there isn’t a hard asset that serves as loan collateral.
To be approved for equipment financing, small business owners must meet specific qualification criteria. Although these are relatively low-risk loans, lenders still want to evaluate the borrower’s creditworthiness before approving the loan application.
Note that the financed amount will dictate the length of the loan or lease. Smaller-dollar short-term contracts may extend just for a few months while longer-term agreements often have repayment terms of up to 10 years.
What type of equipment qualifies for financing?
An equipment loan can be used to replace an existing piece of equipment that’s now obsolete or worn out. Or, the business owner can buy new equipment as the company continues to grow.
Small business owners use equipment loans or equipment leasing to acquire equipment that retains its value over time. Equipment loans are generally applicable to new and used equipment for varied business needs.
Equipment loan qualifications for startups and small businesses
Obtaining approval for equipment financing is similar to getting approved for other business loans. Startups and relatively new small businesses, or companies with past credit issues, may qualify for equipment financing.
Each lender has different approval criteria. However, every business owner should be prepared to meet several minimum eligibility criteria:
- Annual revenues of $50,000 or higher
- A business credit score of 550-600 or higher
- A personal credit score of 650 or higher
- One or more years in business
During the loan underwriting process, lenders may also ask for your identification (a driver’s license will work). If you’re operating a fairly new business, expect to provide details on your personal finances.
To gauge the cash flow of your business, lenders will ask to view your company’s bank statements. Be ready to prepare a profit and loss statement along with a balance sheet. Finally, you may need to provide a detailed business plan that states exactly how you will use the equipment financing proceeds.
Equipment financing costs and logistics
Each lender offers its own combination of interest rates, required collateral, and down payment criteria. With that being said, here are some general numbers to remember:
Each loan structure offers its own range of interest rates. Your rate may vary according to the equipment loan amount.
Some loans require an up-front down payment in addition to the monthly payments. Expect a down payment ranging from 5% to 20% of the loan value.
A self-secured equipment loan uses the equipment as collateral. Note that some loans may also require a blanket lien. This enables the lender to claim your business assets if you default. If the lender requires a personal guarantee, they can lay claim to your personal assets.
Although some equipment loans carry repayment periods of several months, most equipment financing contracts contain repayment terms between 3 and 10 years. Some SBA CDC/504 loans have repayment terms of 10 to 25 years.
The business equipment financing process
When applying for equipment financing, know that loan requests up to $200,000 are usually processed quickly. In fact, you may complete the entire application and closing process within 24 hours.
If you have very good personal credit, and your business has a solid financial reputation, you’ll have a good chance of swift approval. If the financed equipment might retain its value, that’s even better.
If you’re acquiring equipment in excess of $200,000 or purchasing a “big ticket” item, you’ll likely need to provide more equipment information. You’ll also need to prepare additional business documentation. Expect the process to take one to two weeks.
Equipment financing: Pros and cons
Many business owners find equipment financing to be an attractive option. However, this practice does have a few downsides. View the pros and cons objectively before making an equipment financing decision.
Following are some of the key benefits of equipment financing. These attributes should apply regardless of the business type or size.
1. Enables new technology acquisition
A well-structured equipment financing plan enables a small business to take advantage of new technology. While your business utilizes this efficient new equipment, you won’t have to part with valuable cash to buy the item.
2. Extended payment terms
Equipment financing provides business owners with valuable flexibility. The business owner can stretch out a large equipment purchase by choosing a long repayment period. This also increases the amount of available working capital.
3. Fixed-rate loan payments
Most equipment loans carry fixed-rate loan structures. Therefore, your monthly payments will always be the same.
4. Business credit builder
Obtaining an equipment loan and paying it off in a timely manner will help to build your business credit. When applying for a future business loan, your company will have some proof of creditworthiness.
Equipment financing does have four notable disadvantages. These detractors may spur you to search for another equipment acquisition method.
1. Strong credit history preferred
To obtain favorable financing terms, you must have a solid credit background. If that’s not the case, you may be able to get the loan, but your loan costs will be higher.
2. Substantial down payment
Equipment financing requirements often include a hefty down payment. If you’re on a tight budget, that may take this financing option off the table.
3. Non-extendable loan term
Lenders won’t extend the loan term beyond the equipment’s expected value date. If you default on the loan, the lender will need to liquidate the equipment to recoup its costs. The lender’s chances of recovering their investment made on outdated equipment are virtually zero.
4. A potential blanket lien or personal lien
Some lenders may require a blanket lien or a personal lien in addition to the equipment collateral. If you default on the loan, the lender can lay claim to your business or personal assets, respectively.
Finding equipment financing lenders
In choosing an equipment financing source, consider traditional banks, certain credit unions, and financing companies. Some online lenders specialize in equipment financing. Other virtual lenders market general-purpose loans you can use to purchase equipment.
5 best equipment financing companies to consider
Finding the right equipment financing company is important. These five candidates often serve specific market segments.
1. Best Overall: Crest Capital
This well-known company offers up to $1 million loans for new and used equipment. Crest Capital will finance 100% of the loan costs, and often approves companies with limited credit histories. Loan decisions are notably fast.
On the downside, Crest requires applicants’ credit scores to be 650 or better. The company doesn’t clearly explain its collateral requirements. Finally, Crest doesn’t provide financing to startups.
2. Best for Expanding Businesses: National Funding
If your business is preparing to expand, this lender is worth consideration. National Funding finances new or used equipment, and the company doesn’t require collateral or a down payment. And, applicants with a low credit score often receive approval.
However, National Funding doesn’t finance equipment over $150,000. And, it can take several days to receive a loan decision.
3. Best for Bad Credit: Currency
If your business has subpar credit, consider Currency for your equipment financing needs. This company offers up to $500,000 loans for every credit profile. It doesn’t require a down payment and offers fast online approvals.
On the flip side, Currency requires applicants to have $100,000 annual revenues. Subprime credit scores may lead to higher interest rates and/or lower funding limits. And, Currency limits repayment terms to 72 months.
4. Best for Used Equipment: US Business Funding
This lender handles funding for new, used, and third-party equipment sales. US Business Funding processes equipment loans from $10,000 to $2 million, with repayment terms from 3 months to 10 years. The company has a 95% loan approval rate and offers fast credit decisions.
On the negative side, there’s a $75,000 limit for short-form applications, and two-year business history is usually required. And, every financing agreement is technically a “lease.”
5. Best for Large Loans: CIT Bank
This nationally-known lender offers loans for new or used large equipment. CIT Bank processes applications up to $500,000 with no financials required, with up to $100 million via capital equipment financing. Flexible repayment terms are also available.
However, CIT Bank requires a two-year business history. Applicants must also have a relatively high credit score, potentially in the 700 range.
Equipment financing vs other loan options
Equipment financing loans have some notable differences from other business financing options. First, an equipment financing loan can work well for a newer business that’s assembling its production facilities. A newer company might not be a viable candidate for a conventional loan.
An expanding business, or one that must quickly replace critical equipment, might also prefer an equipment financing option. Note that you must use the funds to purchase the documented equipment. This loan structure differs from a more flexible term loan that can be used for varied purposes.
With an equipment financing loan, the financed equipment is used as collateral. This differs from a working capital loan that leverages the creditworthiness of a business into the loan approval.
SBA CDC/504 loans
A Small Business Administration (or SBA) loan is offered through banks and is secured by the U.S. government’s Small Business Administration. CDC/504 loans are intended for the purchase of fixed assets such as equipment.
Highly desirable SBA loans have high loan amounts, low-interest rates, and favorable loan terms. However, these coveted small business loans require great credit, lots of paperwork, and long application cycles.
Newer, less-established businesses don’t qualify for SBA loans. For these companies, an equipment financing agreement can be a valuable conduit that helps them obtain the financing they need.
Often called “traditional loans,” these financing agreements can be used for working capital or equipment purchases. Typically, these loans target more established businesses.
Short- and medium-term loans have a fairly quick application process and fixed weekly or monthly payments. However, note that the loans are structured for working capital, so they may require additional collateral besides the equipment. A blanket lien and/or a personal guarantee might also be required.
In contrast, an equipment financing agreement doesn’t usually require additional collateral. In addition, these loans are accessible to newer, less-established businesses that don’t usually qualify for a term loan.
A business line of credit
Essentially a working capital loan, a business line of credit provides money to buy the equipment your business needs. When you’re approved for the loan, you won’t receive a lump sum that you pay back over time.
Instead, you receive loan approval up to a certain amount, and you “draw” against that amount as needed. You pay interest on the amount of money that you’ve already accessed. In most cases, you can access the full credit line once you’ve paid off the amount of credit used.
These loans may work for newer businesses or those without much revenue to date. To compensate for these risks, however, the lender will often charge higher rates. Equipment financing offers lower interest rates, which means cash-strapped businesses can keep more working capital.
Business credit card
For a brand-new business, a business credit card can purchase a desk or computer that’s essential for business operations. Some business cards feature a 0% introductory APR period, enabling you to finance your equipment interest-free until the period ends.
After the introductory period, you’ll pay interest, which can be higher than a business credit line. Equipment financing has a lower interest rate, which benefits your cash flow.
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Equipment financing vs equipment leasing
There’s a big difference between equipment financing and equipment leasing. With an equipment financing agreement, your business owns the equipment after you have completed all the monthly payments.
Leasing the equipment is just like leasing a vehicle from a dealer. After negotiating the lease terms, your business makes monthly payments to the leasing company to cover the equipment rental costs. By leasing the equipment, you can utilize upgraded technology without impacting your cash flow.
At the end of the lease, you generally have three options. First, you can return the equipment to the leasing company. Or, you can extend the lease and continue making lease payments while you keep using the equipment. Or, your business can purchase the equipment from the lender.
One notable downside of equipment leases is the high cost. Over time, you’ll pour more money into the lease than the equipment’s purchase price. This arrangement doesn’t benefit your company’s bottom line.
When equipment financing isn’t the right choice
Despite its advantages, equipment financing may not always be the right option for your business. Here are three situations in which you should consider other options:
1. Prohibitive down payment
A lender might decide to finance only 80% of the equipment’s cost. If so, you’ll be expected to cover the remaining portion. If your business is strapped for cash, consider leasing the equipment.
2. Excessively high interest charges
Your equipment financing interest rate depends chiefly on the creditworthiness of your business. However, note that the APR often depends on the equipment’s resale value, not your business financials. This could result in very high interest charges.
3. Easily outdated equipment
Before financing an equipment purchase, you must learn how well the item retains its value. Avoid financing equipment that will become obsolete when you have paid off the loan. If your industry is known for rapid innovation, consider leasing the equipment instead.
Should you finance equipment?
After taking stock of your equipment needs, review the available equipment payment methods. Compare the pros and cons of each, and carefully read reviews of specific companies.
Next, thoroughly consider your company’s financial position. Make an honest assessment of the financing option you can best afford. Then, make the decision that’s most likely to support the growth of your small business.
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