Equipment financing: pay for the machine while it earns

Equipment financing pays for machinery, vehicles, tools or technology over time, with the equipment itself as security. Because the lender can take the asset back if you stop paying, it is usually priced lower than unsecured working capital, and the terms run longer. The main decision is loan or lease, and the main mistake is a term longer or shorter than the machine's useful life.

Loans and leases

A lease with a nominal buyout behaves much like a loan. A fair-market-value lease is closer to renting: lower payments, but nothing to show for them at the end unless you pay again to keep it.

How the cost works

The cost is driven by the rate and the term. Here's the maths on $100,000 of equipment at an assumed 12% APR, repaid monthly:

The longer term cuts the payment by about $409 a month and costs about $7,064 more in total. That trade can be right if the machine will still be earning in year five and the lower payment keeps your cash flow comfortable. It's wrong if the machine will be obsolete in year three, because you'll be paying for something you've already replaced.

The 12% is an assumption for illustration, not a quote; rates depend on your credit, the equipment and the term. Put your own offer into the loan payment calculator.

For a lease, ask for the total of all payments plus the buyout, then compare that with the cash price. The difference is your financing cost, and you can turn it into a rate the same way.

Who it suits

• A business buying an asset that directly earns: a kitchen line, a CNC machine, a dental chair, a delivery van, a commercial mower fleet.
• Owners who would rather keep cash for working capital than tie it up in kit.
• Businesses whose credit or time trading makes unsecured money expensive, because the asset carries some of the risk.

Who it doesn't suit

• Soft costs with no resale value: software subscriptions, training, installation labor. Some lenders will roll a share of these in, but they lean on the asset.
• Very specialized equipment with little resale market, which lenders may price higher or decline.
• A business that needs flexible cash rather than a specific asset. See working capital financing.

What lenders look at

• The equipment. New or used, make and model, resale value and expected life.
• The quote or invoice from the vendor.
• Time in business and revenue, usually from bank statements and tax returns.
• Personal credit of the owners.
• Down payment. A deposit lowers the lender's risk.

Most lenders file a UCC lien on the equipment, a public notice that they have a claim on it until it's paid off. Check whether the lien covers only the equipment or all business assets; a blanket lien makes it harder to borrow elsewhere.

SBA programs can also fund equipment. The SBA 504 program covers capital assets including equipment, with loans from $25,000 to $5.5 million and terms of 10 years for equipment, and 7(a) loans can fund machinery and equipment too. Those go through banks and Certified Development Companies; see SBA loans for who they suit. Ask Sterling and our funding partner don't arrange SBA loans.

Questions to ask before you sign

• What is the cash price, and what is the total of every payment plus any buyout?
• Is the rate fixed for the whole term?
• Is there a down payment, and are there documentation or origination fees?
• What does the lien cover: this equipment only, or all business assets?
• Who pays for insurance and maintenance during the term?
• Can I pay off early, and what does that save?
• On a lease, what are my options at the end, and how much notice do I have to give?

Red flags

• A lease that doesn't state the buyout amount in writing.
• An "evergreen" clause that renews the lease automatically if you miss a narrow notice window.
• A blanket lien on all business assets for a single piece of equipment.
• A term longer than the equipment's useful life.
• A vendor-arranged deal where the "discount" on the price is clawed back in the financing.

Sterling's take: ask the vendor for the cash price before you discuss financing. If the financed price is higher, that's part of the cost of the money.

How it compares

If you need the asset and some cash besides, a term loan can cover both, usually at a higher rate than an asset-backed deal.