Equipment is essential for running a business, but buying and maintaining equipment can be expensive.
Tying up your working capital in order to replace, upgrade or purchase equipment for the first time can put a serious strain on your cash flow, so choosing the right form of financing can prove crucial.
When your business needs equipment but you don’t have the cash to buy it outright or you want to spread the cost over a longer period you have two options: equipment loans or leasing.
The key difference between the two stems from the ownership of the equipment – in case of a loan you are the owner and in case of leasing it’s the lender. This fact will have different business, accounting, and tax implications.
How it works?
In the case of an equipment loan you buy the equipment and become the owner of the asset. The loan can be obtained from a variety of sources depending on your credit standing and the equipment:
Traditional lenders like banks and credit unions will generally have more strict approval standards, but that can work to your advantage if you have a higher credit score and can qualify for a lower interest rate.
There are multiple government programs, like the Canada Small Business Financing Program, designed to make it easier for small businesses to get loans from financial institutions.
Loans of up to $1,000,000 are available through this program for Canadian small businesses or start-ups with gross annual revenues of up to $10 million. As financial institutions deliver the program and are solely responsible for approving the loan, you should discuss your business needs with a financial officer at any bank or credit union in Canada.
Online lenders will typically have easier and faster application procedures.
In addition, dealers and equipment financiers can also provide loans for equipment acquisition.
Equipment Financing Pros
- Easier to qualify and less documentation is involved compared to term loans where you need to document years of financial history and a good credit score;
- Equipment ownership – you become the owner of equipment from the beginning which will have accounting benefits through depreciation;
- You pay equal monthly payments until the equipment is paid off. With a lease, if you want to purchase the equipment at the end of financing term, you may have to make a large lump sum payment;
- No additional collateral needed;
If you need equipment, instead of buying it, you can lease it. In a lease, it’s the lender that purchases the equipment and then leases (rents) it back to you for a monthly fee. At the end of the lease term, you can have an option to renew the contract, to return the equipment or to buy it outright.
Equipment Leasing Advantages
- No down payment required, leaving you more cash on hand;
- No collateral needed;
- Easier application process compared to equipment loans;
- Lender is responsible for repairs and maintenance;
- Flexible financing terms as you can select payment schedule that suits your business’ dynamics: annual, semiannual, monthly or even seasonally adjusted;
- It does not affect your level of indebtedness and other financial ratios. This can prove beneficial if you want to get additional financing in the future or you are planning to sell your business;
- It helps you have up-to-date technology.
- If you’re in a field which requires frequent equipment upgrades, leasing may be a better option as you can return the equipment at the end of the lease and enter a lease on new equipment;
Equipment Leasing Cons
The fee will depend on your personal credit score, your business’ key indicators, but also on the equipment and how well it holds its value over time. Since the price you pay does not only depend on your business characteristics but also on the characteristics of the equipment, you may find yourself paying more than you would if you had taken out an equipment loan where lenders generally look at your business only when making a financing decision.
How to make a decision
Whether to finance through leasing or a loan depends on individual circumstances. When researching equipment financing, there are several things to pay attention to:
- Consider whether equipment ownership is important/beneficial for your business. If you are in a traditional sector where technology does not change quickly, you may prefer ownership and therefore opt for a loan. If you are in an industry where technological changes are frequent, then buying equipment does not make financial sense;
- Consider whether a down payment is a viable option for you;
- Take into account the total cost of borrowing including hidden costs like a loan origination fee or an annual maintenance fee;
- Consider all financing conditions. Term length will affect cash flow and tax considerations (tax advantages may vary over time). Also, consider whether additional collateral or guarantees are required, particularly if any lien over personal assets is required;
- Consider the minimum approval conditions and whether you qualify;