Equipment Financing: Pros, Cons, and Alternatives
Equipment financing can be a powerful tool for growing your small business.
Whether you’re looking to ramp up production, expand your geographical reach, or enter into a promising new product line, you may be wondering whether equipment financing is the right way to achieve your goals.
In this article, we’ll briefly define equipment financing, cover some advantages and disadvantages of this form of small business borrowing, and offer some alternative approaches.
What Is Equipment Financing?
Equipment financing is a type of asset-based commercial lending that specifically funds tangible fixed assets like machinery, tools, computer systems, office furniture, and company vehicles.
Typically, equipment financing comes in the form of a term loan, meaning you’ll receive a lump sum upfront and repay it in set monthly installments. These loans are often self-collateralizing, meaning they’re secured by the assets they finance – so your lender can repossess them if you default on the loan.
Equipment financing is available from a variety of sources, including banks and credit unions, specialized online lenders, certain equipment vendors, and government agencies.
Financing vs. Leasing
One decision that many entrepreneurs have to grapple with is whether to finance or lease key fixed assets. Durable goods like heavy farm machinery and commercial kitchen fixtures are usually good candidates for financing. For big-ticket items that provide utility only for a particular season or project or that are likely to become obsolete quickly, leasing may be the better choice.
Pros and Cons of Equipment Financing
Like any type of financing, equipment-specific loans come with various benefits and drawbacks – and every small business owner will weigh them differently depending on their unique circumstances and objectives.
- You can avoid cash flow issues by spreading out the cost of major purchases.
- You can leverage the revenue-generating power of the equipment sooner than if you were to save up for an all-cash purchase.
- You may be able to secure more favorable rates and more flexible terms than with other types of small business loans.
- You may not need to put up any personal or business assets as collateral besides the financed equipment.
- You may be able to quality for a self-collateralizing equipment loan even if your credit is less than stellar.
- You can help your business to build credit with consistent loan payments.
- You may get tax relief at the end of the year, including interest and depreciation deductions.
- You will own the equipment outright once the loan is repaid – and you may be able to use it to secure funding in the future.
- You may be able to use the loan funds only to buy equipment, while other loan types offer more flexibility.
- You will spend more in the long run than if you pay cash – and you might still be making payments beyond the equipment’s life span.
- You may be offered less favorable terms if your lender isn’t confident in the aftermarket value of the equipment.
- You risk having your equipment repossessed if you don’t pay back the loan in full and on time.
- You may be subject to a blanket lien or other restrictions if your qualifications aren’t top-notch.
- You may have to come up with a sizeable down payment.
- You may not be able to secure a loan amount that covers transportation, installation, and other costs.
- You will be responsible for maintenance and repairs, while some operating leases may include a service agreement.
Alternatives to Consider
Equipment-specific loans and leases aren’t your only options, even if obtaining fixed assets is your most pressing need. Here are seven other small business funding solutions you should know about:
- Term Loans
Whether secured or unsecured, these may have stricter requirements but can give you the freedom to cover payroll or other needs.
- Lines of Credit
These let you withdraw smaller amounts as and when needed, if your equipment needs are more unplanned.
- SBA 7(a) Loans and 504 Loans
Backed by the federal government, these products are often desirable because of their lower interest rates and down payments.
- Business Credit Cards
Though you need to exercise caution, credit cards can be a workable solution for newer businesses or smaller equipment purchases.
- Accounts Receivable (A/R) Financing
This option enables you to leverage your outstanding invoices to get funding with no additional collateral requirements.
It’s an increasingly popular way to raise capital that leverages the power of your social networks, and it can also serve as an effective marketing tool.
- Angel Investors
They can be hard to attract, but they’re worth pursuing if you have an out-of-the-ordinary growth strategy and a persuasive pitch.
To find out what lending solution might work best for your business’s unique circumstances and objectives, reach out to one of ENB’s Small Business Relationship Managers.