For many businesses, whether they have used it or not, equipment financing is probably the most familiar form of asset-based lending. That is because it is the easiest to understand and, for the most part, the easiest to obtain. Financing is based on the equipment being purchased which is used as collateral for securing the loan. Lenders view it as fairly low risk financing because it is backed by the value of the equipment; and it is advantageous for businesses that either can’t come up with the capital for a purchase or would rather use their capital for other purposes. Beyond that, there are several aspects of equipment financing a company needs to understand before taking out an equipment loan.
How Equipment Financing Works
When financing equipment with a loan, the lender uses the value of the equipment to determine a borrowing base, which is the amount of money a company can borrow. For equipment, the borrowing base is a percentage of the market value of the equipment, which is typically based on a loan-to-value (LTV) ratio of 50%.
Loan terms can range from one to seven years, depending on the type and value of the equipment and loans are priced using an annual percentage rate (APR). The APR on bank financed equipment loans can range from 7 to 17% depending on the size of the loan, the type of equipment and the company’s creditworthiness. Companies that can’t qualify for a bank equipment loan can usually qualify through an alternative asset-based lender, but they can expect a higher APR range of 12 to 40%. Generally, the longer the loan term, the lower the APR.
When financing equipment, a company should obtain terms that work best for the equipment they are purchasing. For example, the company should not consider purchasing equipment with a shorter life span than the length of the loan. If a company has to carry a high APR on a short-term loan, it should have a definitive plan for paying off the loan as quickly as possible.
Where to Obtain Equipment Financing
Equipment financing is available through a range of lenders, including traditional banks, commercial lenders and alternative lenders. Ultimately, the choice of lender comes down to the company’s credit standing. While traditional banks and commercial lenders offer the best loan terms (i.e. lower APRs, more repayment options, etc.) they typically have stricter qualifying requirements. It may be easier to qualify for an equipment loan from an alternative lender, but the APR is likely to be higher with less flexibility on loan terms.
Banks and Commercial Lenders
Banks specializing in business lending tend to offer a wider variety of loans with more favorable terms; however, their qualifications can be a high hurdle for many mid-sized businesses. Although it is easier to qualify for an equipment loan because it is asset based, banks still consider the creditworthiness of the business. Credit unions may have more favorable terms on equipment loans and the willingness to work with a business with less than great credit, but the business or business owners must be a member.
Equipment loan APRS can be fixed or variable, ranging from 6 to 12% depending on the loan amount, the loan term and the company’s credit standing. Many banks are able to structure the loan based on the useful life of the equipment with a repayment schedule compatible with the company’s cash flow. Companies with less than great credit may still qualify for an equipment loan, but they can expect to pay more in interest charges.
Some banks require a down payment of up to 20% of the market value of the equipment. Although some banks may require a lower down payment or no down payment at all, companies can obtain better loan terms with a larger down payment. Most banks will also require a personal guarantee on the loan.
Non-Bank Asset-Based Lenders
Over the last decade, non-bank asset-based lenders have proliferated, offering mid-sized companies more financing alternatives. The structure of an equipment loan through an asset-based lender is essentially the same as it is with a bank, except it may not offer as many repayment options and, depending on a number of factors, it may charge a higher APR. Most asset-based lenders will finance up to 100% of the equipment’s LTV; however, they tend to offer shorter loan terms.
The primary advantage of working with an asset-based lender is the greater leniency in its credit qualifications. Mid-sized companies that are unable to qualify for a loan through a bank can usually qualify through an asset-based lender. Some asset-based lenders give more weight to the length of time a business has been operating and its annual revenue than the business’ credit score.
Generally, the application and approval process with a non-bank asset-base lender is much shorter – a matter of days instead of weeks with a bank – making it good option for companies that need to acquire new equipment quickly.
For many mid-sized businesses equipment financing is the best way to secure funding for the purchase of new equipment. It is easier to obtain than other forms of financing and it affords the business the opportunity to utilize the equipment to generate more revenue for paying off the loan. Businesses can reap the benefits of brand new equipment while enjoying the tax benefits of ownership.
