What Is Equipment Financing? 

Whether you operate a popular restaurant in town or haul food supplies across the country as an owner operator trucking company, you'll need equipment to stay in business. However, purchasing new equipment can be really expensive and can disrupt cash flow when not executed properly. Equipment financing is a tool that business owners use to acquire the capital that they need to purchase equipment without relying on large cash reserves. Consider how equipment finance arrangements work and their benefits to determine if one is right for your business. 

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How Equipment Financing Works?

Equipment financing involves obtaining funds from a lender to purchase necessary equipment for your business operations. The process starts by selecting a lender, and business owners typically have two main choices: traditional banks and specialized lenders.

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Traditional Banks:

When you finance equipment via a bank, the bank assesses your personal and business credit worthiness and makes you a loan offer. The offer includes interest and principal payments that are paid monthly. Depending on the terms of your loan, banks use both financed equipment and your other business assets as security for the loan. If you've made a personal guarantee to repay the loan, your personal assets are also considered collateral for the loan. Failing to repay the loan on time means that your assets are subject to forfeiture.

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Getting 100% financing for your equipment via a bank loan is uncommon. Usually, banks want you to pay a small percentage of the equipment's cost using your cash reserves. This can be up to 20% of the total cost of the equipment.

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Specialized Lenders:

You'll find that financing equipment through a specialized lender is easier and more convenient than getting a bank loan. These lenders often have lower credit score requirements than banks, and they process loan applications more quickly via online platforms. However, you'll pay for this convenience. Specialized online lenders offer less favorable loan rates and terms than traditional banks.

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Many of these lenders only require the financed equipment to be used as collateral and not other business or personal assets. You'll need to shop around to find the loan product that's right for you. 

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What Are The Lender Requirements?

If you're at all familiar with getting business loans from banks, you know that just getting through the application process is a harrowing experience. Traditional banks profit by lending money at interest rates that the market can bear. Their loans take risk into consideration, and they write loan terms that protect their financial interests against nearly all types of defaults. Take a look around at the small number of banks that have gone bankrupt in modern times, and you'll realize that these lending institutions know a thing or two about balancing money-making activities and risk management.

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As a result, a bank will often ask you to fill out a preliminary application. This document helps to screen out businesses that don't meet the bank's absolute minimum loan requirements. Banks may ask about your company's annual revenue and how long you've been in business. If your company has less than $250,000 of annual revenue and is a year-old startup, it's likely that the loan processor will let you know that your company doesn't qualify for an equipment loan.

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If you meet the bank's minimum requirements, you'll be asked to prove it. The bank will ask you to provide at least two years' worth of financial statements and tax documents. It's not uncommon for a bank to also ask for your personal bank statements and tax returns.

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Specialized online lenders use a much more streamlined application process. They want to know about your current debts, expenses, and income, but they don't belabor the point. After getting a copy of your financial documents, they perform analysis and provide a loan offer within a few days versus a few weeks, which is the approximate length of time that banks take to process business loans. You're more likely to get approved for an equipment loan with some specialized online lenders than with traditional banks. They often have lower threshold requirements for loans but hedge their risks with higher interest payments. While both traditional banks and specialized lenders run credit reports during the loan application process, specialized lenders consider loan applications for businesses that have lower credit scores. Traditional banks will not.

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Benefits of Equipment Financing

Equipment financing offers a variety of benefits to business owners, including:

1. ‍Preserving Cash Flow: One of the most significant advantages of equipment financing is the ability to purchase necessary equipment without making a large initial outlay of cash. This helps maintain cash flow for other essential business operations.
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2. Flexible Repayment Options: Equipment loans often come with structured repayment plans tailored to the borrower's ability to pay. These structured payments can make budgeting more manageable over time.
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3. Ownership and Equity: Once the loan is paid off, the business owns the equipment outright. This ownership provides long-term value and allows the business to use the equipment as collateral for future financing needs.
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4. Tax Benefits: In many cases, businesses can deduct loan interest and depreciation expenses associated with the financed equipment, reducing their overall tax burden.

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‍Alternatives to Equipment Financing

If equipment financing does not align with your business's current needs, other funding options are worth considering:

Leasing: Leasing equipment can be an effective alternative if your business requires equipment that needs frequent upgrades. With leasing, you do not own the equipment but instead pay a monthly fee to use it. This option allows you to keep up with technological advancements without the long-term commitment of owning the equipment.

Invoice Factoring: Invoice factoring is an alternative for businesses needing fast capital for equipment replacement or other needs. This process involves selling outstanding invoices to a factoring company at a discount in exchange for immediate cash. The benefit of invoice factoring is that it does not create debt, as it is not a loan. Once you receive the cash, you can use it freely without restrictions.

Business Line of Credit: Establishing a business line of credit provides flexible funding that can be used for various expenses, including equipment purchases. Unlike traditional loans, you only pay interest on the amount you draw, giving you greater control over your financial obligations.

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Conclusion

Equipment financing can be an effective way to obtain the machinery and tools necessary to operate and grow your business. It offers benefits such as preserving cash flow, structured repayment options, and potential tax advantages. However, it comes with its set of challenges, including strict qualification requirements and potential risk if monthly payments become unmanageable.
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Before committing to an equipment loan, assess your business's financial health and long-term needs. Evaluate alternative options like leasing, invoice factoring, or a business line of credit to ensure you choose the most suitable funding strategy for your situation.
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By carefully considering your options, you can make an informed decision that supports your business's growth without compromising its financial stability.