Despite some major advances in loan accessibility, the small business financing market continues to be fraught with red tape and riddled with excessive amounts of financial jargon. As a result, small businesses often find themselves at a disadvantage when it comes to securing funding, they need to scale their operations, acquire new equipment, and hire new employees.
To raise capital quickly and safely, small business owners are increasingly turning to more specialized loan instruments. Equipment financing loans are one of several loan products that have been gaining momentum in recent years.
Read on to learn how equipment financing works, the advantages and disadvantages of using this loan product, and the best ways to structure an equipment financing deal as a small business owner.
What is Equipment Financing?
As the name suggests, equipment financing is usually taken out to cover the cost of purchasing new machinery or upgrading outdated equipment. This can range from ordering large-scale farming or construction equipment to procuring specialized heavy machinery.
The main difference between conventional business financing loans and equipment financing is the method of securitizing the loan. A conventional bank loan will typically assess business liabilities and cash flow to determine if you can meet their proposed repayment scheme. With an equipment financing loan, small business owners can minimize their underwriting requirements by securing their loan to the equipment they intend to purchase.
This process, sometimes known as asset-based lending, helps to mitigate risk for the lender, as their loan will be collateralized by a physical asset. Prior to approval, lenders will require an appraisal of the equipment to ensure its value is sufficient to support the loan. Depending on the equipment and its value lifecycle, lenders may also request additional collateral to offset the risk of equipment depreciation.
Despite these requirements, equipment loans tend to be one of the quicker ways to access business financing. Barring any hiccups in the loan application, most business owners should be able to secure their equipment financing loan within 24-48 hours. This is a big advantage over other commercial or SBA loan products, which typically take an average of two to four weeks to process.
What Businesses Qualify for Equipment Financing Loans?
Equipment financing works best for small businesses that require equipment to scale their operations, as well as equipment that provides a significant increase in productivity. We’ve included a non-exhaustive list of possible items that might qualify for equipment financing below:
• Construction equipment (i.e. excavators, graders, or cranes)
• Farming equipment (i.e. tractors or combine harvesters)
• Industrial machinery (i.e. grinders, millers, or sheet metal machines)
• Information technology (i.e. enterprise servers or computing infrastructure)
Pros and Cons of Equipment Financing
The main advantage of an equipment financing loan is the ability to simultaneously finance both the purchase of the equipment and the collateral for the loan in a single financial instrument. This is especially important for businesses that need additional equipment in order to continue growing their business. Instead of allocating months of earnings to expensive and time-consuming equipment purchases, small business owners can utilize equipment financing to scale up quickly.
What’s more, because business equipment purchases often run into tens or even hundreds of thousands of dollars, the collateralization of this equipment provides lenders with additional security to protect against default. As a result, small business owners may benefit from more attractive lending terms and lower interest rates.
Nevertheless, equipment financing is not without its downsides. Firstly, because the funds are contractually allocated to specific equipment, there is no flexibility to use the loan as liquidity or accessible cash. Secondly, as the equipment in question is secured to the loan, you will be unable to sell the equipment until your loan is repaid in full.
Remember, equipment financing works best for businesses that require new and/or additional equipment to expand into new markets or service more customers. If the equipment you purchase doesn’t translate to an increase in revenue, then you may encounter cash flow issues when paying down the secured loan. Therefore, you will need to carefully consider how much equipment you need to scale up your business and how much demand there is in your target market.
The Bottom Line
Equipment financing is an effective strategy to leverage new and innovative instruments to increase business growth and expand into new markets. It allows small business owners to obtain a loan for the equipment they need while providing a more favorable interest rate than traditional bank financing.
However, taking on debt to purchase equipment is a large financial commitment, and as you look to the future of your business, you need to be aware of the risks that come with this type of funding. As always, make sure you fully understand your collateral risks, repayment terms, and any possible cash flow constraints before you decide to take on equipment financing.
