For many businesses, acquiring the equipment they need to run their operations can be extremely difficult, if not impossible. This is where equipment financing comes in.
It is a type of business loan that helps businesses get access to that equipment. They obtain it through a financier, often on a lease basis, with the equipment used as collateral for the loan.
This means they don't need to invest a large amount of capital, but can still launch, run or expand their operations. Equipment finance, also known as asset finance, takes care of the initial outlay. In the event of a default, there is a possibility that the equipment can be repossessed.
What is equipment finance used for?
Equipment finance can be used to purchase:
- Heavy machinery used for industrial businesses (manufacturing, construction, farm, agriculture) or industrial kitchen equipment
- Shop fit-outs
- Vehicles, including forklift trucks, vans or a fleet of cars (also known as vehicle finance)
- Office equipment such as computers, laptops, printers, desks, chairs and other furniture
- Technology, including high-tech equipment and servers
- Medical and scientific equipment
Advantages and disadvantages of equipment financing
|It means you don’t own obsolete equipment. There may be an option to upgrade the equipment at the end of the loan or it can be taken back by the financier||More expensive than buying equipment outright|
|If you fail to repay the loan, your business or property cannot be repossessed, only the asset secured by the loan||Failure to repay means losing an asset that is probably essential to your business' operation|
|Easier to obtain than a business loan - less stringent eligibility criteria and less paperwork required||Long repayments with high-interest rates and fees|
Which type of equipment finance?
There are several different types of equipment financing and determining the one for you depends on your business and the type of equipment needed. For example, at the end of the loan term and with all payments made, the equipment could belong to either the borrower or the lender. When deciding on a type of loan, there are a few important considerations:
- How long will the equipment be needed for?
- Will it become obsolete or need replacing or upgrading after a certain period of time?
- How quickly is technology evolving in your industry?
Chattel mortgage - a borrower will purchase and own the asset with a loan from a lender. The assets serve as security in the case of default.
Commercial hire purchase - the financier purchases the equipment and leases it to the business with fixed repayments over a specified period of time. They own the equipment until all payments along with interest are made, at which time ownership will transfer to the borrower.
Operating lease - similar to commercial hire purchase, except the asset belongs to the lender at the end of the lease. Alternatively, it can be purchased by the borrower at an agreed price. This type of finance lease is ideal in industries where assets are subject to depreciation or obsolescence.
Difference between asset-based lending and asset finance
Whilst equipment finance or asset finance is used by businesses to fund the purchase of equipment, asset-based lending uses assets already owned by the company as collateral for a loan. A business will use its fixed assets to obtain the loan rather than relying on the financiers' perception of their creditworthiness.
A business will use the assets already on its balance sheet to borrow money. This could be inventory, accounts receivable, machinery or property. The loan amount cannot exceed the value of the asset it is secured against. The loan term cannot exceed the lifetime of those assets and depreciation is taken into account by the financier.
Capital secured by asset-based lending is generally used for short-term funding requirements such as:
- Raw material or stock opportunities
- Ongoing working capital needs
- Funding growth
- Paying employees
Advantages and disadvantages of asset-based lending
|Less stringent lending criteria means it is generally easier to obtain than a traditional business loan||Low valuations of assets and depreciation can affect the amount being borrowed|
|Fixed monthly repayments and interest rates make budgeting easier||Not recommended as a long-term funding solution|
|In the event of a default, only the assets used as security can be repossessed||However, could lose an asset that is essential to the business' operation|
Asset-based funding is a financing option used by businesses whose financial situation means they cannot get funding another way. This includes start-ups and small companies who lack the financial history or credit rating of more established businesses.
There is a wide range of other small business loan options:
Business line of credit
Funds can be drawn-down, repaid and drawn again. Repayments are flexible and interest is charged based on the balance and only when the account is used. Fees apply based on the full credit limit. A flexible source of commercial finance, without fixed repayments or the need to reapply.
Used for planned expenses (payroll, operating costs, stock).
Like a business line of credit but is usually part of a regular business bank account. As such many businesses have one. Transactions and withdrawals can be made up to an agreed amount beyond the limit of the account. Funding can be drawn and redrawn up to that limit without the need to reapply.
Used for short-term working capital needs and unexpected expenses.
Business credit card
A revolving line of credit like a business overdraft, but not attached to a transaction account. Often used for minor expenses and repaid within the same month, otherwise, it can attract high fees.
It is generally not recommended for cash flow and operating costs, due to the high rates.
A line of credit or upfront funds based on a business' unpaid invoices. Comes in two main forms; invoice factoring and invoice discounting. With factoring, the invoice ledger is sold, and collections become the responsibility of the lender, and with discounting, the invoices are used as security and collections stay with the business.
Used to help with day to day cash flow needs, whilst waiting for invoices to be paid.