When running a business, there will most likely come a point where you have to make a big purchase. There are times, especially during the startup phase, where the cash you have on hand can't cover a big expense you need to keep your business running.
Financing equipment can be particularly expensive for business owners, but it's often one of the most necessary expenses. If you don't have the cash to buy your own computers, vehicle, machinery, or other piece of equipment outright, you have two options: take out an equipment loan or a lease.
While both options get you the equipment you need to run your business, they are quite different in practice. Let's evaluate each option so you can make the best decision for the future of your business.
Equipment financing, or an equipment loan, allows you to borrow the amount required to purchase a piece of equipment, which you pay back over time. After qualifying for this financing, you're eligible to borrow a specified amount based on the amount the equipment is worth and whether you'll be purchasing it used or new.
An equipment loan puts the equipment itself up as collateral against the amount you borrow (and it typically won't require you to put up additional collateral). This makes it somewhat easier to qualify for than other types of business loans since your business history and revenue don't factor into the application process quite as much.
Of course, as with any loan, equipment financing means you will end up paying extra in interest. Most of these loans come with an APR ranging from 8 to 30 percent.
Benefits of an equipment loan
An equipment loan has benefits that extend beyond simply providing you a way to finance equipment. In fact, it's a great way to start building your business credit score in the startup phase of your business.
Additionally, equipment financing requires much less documentation than other business loans. Lenders will be less concerned with your business history and credit score, as the equipment itself will be used as collateral.
Equipment financing also gives your business another asset once the equipment is paid for. If you know you'll want to take out a business line of credit or other business loan in the future, this additional asset could be extremely helpful in your application.
Finally, you can take advantage of certain tax incentives when financing equipment, as it is often entirely tax-deductible for small business owners.
If you need to find a way to afford a piece of equipment for your business without paying a costly upfront amount, equipment financing may just be right for you.
If you've ever leased a car or rented an apartment, you are already familiar with how equipment leasing works. It's quite simple: You pay a flat monthly fee for the duration of your lease. At the end of the lease term, you either renew your lease or return the equipment.
Unlike an equipment loan, an equipment lease does not require collateral. It also doesn't require a down payment, and you do not own the equipment when all is said and done.
However, once you've reached the end of your lease agreement, you typically have the option to purchase the equipment for its fair market value.
Benefits of an equipment lease
Like an equipment loan, an equipment lease doesn't require you to pay a large sum of money upfront. If you can't afford to purchase a piece of equipment, a lease may make the most sense for your business.
The tax incentives for equipment leasing are also the same as they are for equipment financing. You may even be able to deduct the entire cost of your equipment lease from your business taxes.
Equipment leases differ from equipment loans in that they offer you more flexibility in the long run. If you work in a field where you need to constantly upgrade equipment to the latest model, it may not be worth it to continue purchasing new technology or machinery.
Taking out a lease makes it easier to continue upgrading your equipment along with the cycle of your industry without having to figure out how to sell off outdated equipment.
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Is a loan or lease right for me?
When it comes down to it, the answer as to which financing option is right for you depends on the specific piece of equipment you're looking to obtain.
As with leasing a car, an equipment lease may be more expensive over time than simply buying the equipment outright. However, if you don't have the cash on hand to purchase it outright, a lease may simply make more sense for your expanding business.
Additionally, if you work in technology or another field where equipment rapidly becomes obsolete, it may make more sense for you to lease. That way, the heavy turnover of equipment may not cost you as much in the long run.
If you're in the market for a piece of equipment that you know you'll use for years to come, however, then a loan may make the most sense. For example, purchasing all the large kitchen appliances for your new restaurant's kitchen is a costly undertaking that you won't want to repeat every few years. You'll want to purchase equipment that lasts and keep it.