The first few months of your business can be critical to its longterm success. When you’re running a startup business, you’re an unknown quantity; your customer base hasn’t solidified, and many lenders may be reluctant to take a risk on you.
Still, you’ll need to find ways to get the equipment you need to make your business a success. If you’re not independently wealthy, that means getting financing. Below, I’ll walk you through some of the ways you can use loans and leases to finance your equipment and get your startup off the ground.
First: What Is A Startup?
The word “startup” is often fetishized in the business world, conjuring images of sweatshirt-wearing innovators living in pods in the Bay Area, and eventually pushing out some kind of software application.
The truth, however, is that you don’t have to be a Stanford whiz kid with shadowy angel investors to have a startup. You just have to be running a new business–typically between zero-to-two years old, sometimes three–that’s trying to capitalize on perceived market demand. Startups are usually at a stage of development where their revenue is uncertain and may not be able to sustain the company long-term without a larger clientele or a cash infusion from those venture capitalists we’re always hearing about.
Because they’re at a stage where their finances aren’t stable, startup owners often have a hard time accessing other types of lending. Equipment financing, however, has some properties that can make it accessible even to startups.
How Equipment Financing Works
Equipment financing, as you may have guessed from the name, covers financial products designed to help the borrower (or lessee) acquire physical assets for your company. This can include anything from vehicles to ovens, computers, heavy machinery, etc.
Why is there specialized financing for these types of expenses, and why should startups care? Well, because you’re dealing with a physical asset that has resale value, your lender can place a lien on the equipment you purchase, allowing it to serve as collateral for the loan. If you default, the lender can repossess the item and resell it. This mitigates some of the risk lenders take on when they’re dealing with entities that don’t have a long, stable history. Essentially, all equipment loans are secured loans. Leases have their own logic, which I’ll touch on in the next section, but they also benefit from working with a transferable product.
Equipment Loans VS Equipment Leases
One of the more confusing aspects of equipment financing is that it encompasses two very different types of financing that are, nevertheless, discussed interchangeably. These are equipment loans and equipment leases.
Let’s start with the more familiar: equipment loans are installment loans used exclusively to acquire hard assets. They use the asset as collateral for the loan, ofter resulting in better terms than you’d see for, say, a comparable working capital loan. Payments, made monthly, are usually spread out over a pretty long window (three to seven years). In most cases, you’ll be expected to make a downpayment on the equipment in the neighborhood of 15%. Equipment loans usually have better rates than comparable leases.
Equipment leases are a universe unto themselves. While they were traditionally used for renting equipment, and still are, leases encompass far more than simple rental agreements. Depending on the lease agreement either you or the financing entity (called a lessor) own the title for the equipment for the duration of the lease. This has fairly profound tax ramifications, so make sure you talk to an accountant if you’re trying to maximize your value here. Like loans, leases spread the cost of your equipment plus interest over the course of the term length. Unlike loans, some of the cost is leftover after the term length, an amount called a residual. This amount may be as little $1, or as high as the fair market value of the product. How much it is depends on the type of lease you got. Capital leases, which are meant to replace loans, typically end with a small residual and you assuming full ownership of the equipment. Operating leases, often shorter in duration, will leave a larger residual, but you’ll have the option to return the equipment as well as buy it. Leases also typically finance the full cost of your equipment, minus the first and sometimes last month’s payment, which can make them a better option if you don’t have a large sum of cash laying around.
5 Reasons Equipment Loans & Leases Are Good Options For Startups
So now you know that equipment financing is at least an option for financing your startup business costs. Here are some pros to using equipment loans and leases as a startup:
1. They’re Easy To Qualify For
I touched on this above, but equipment loans and leases carry less risk to financers than unsecured loans and don’t require you to come up with an exotic source of collateral like most other types of secured loans. The result is financial products that are more accessible to startups.
2. No Collateral Requirements
It’s not every day you can get a secured loan without actually having to put up any of your own collateral, but equipment financing allows you to do just that. With equipment financing, the equipment you’re acquiring is the collateral.
3. Equipment Vendors Want To Give You Financing
Companies that sell big-ticket items know their products are expensive and hard to buy with petty cash. Because of this, many provide captive lessors. Essentially, they’ll lend you money to buy their product. Weird, right?
4. Bigger Downpayments Can Circumvent Qualifications
Equipment loans and leases are generally easier to qualify for to begin with, but you have some additional leverage that you don’t have with many other types of financing: if you can manage a bigger downpayment (or pay for an additional month in the case of a lease), the financer may waive some of their qualifications.
5. You Can Rent Equipment That Depreciates Quickly
Some types of equipment (think computers) have much shorter effective lifespans than others. Operating leases allow businesses to use and then return equipment that may not make a good longterm investment.
5 Reasons A Startup Should Avoid Equipment Loans & Leases
Equipment loans and leases have advantages, but are they really a good idea for your business? Let’s explore some of the downsides:
1. They Can Be Expensive
Anything involving accumulated interest can potentially be a trap for the unprepared, and equipment financing is no different. Leases, in particular, can carry punishing interest rates that get hidden within their complicated terms. Calculate how much you’ll ultimately be paying above the equipment’s ticket price and decide if the investment is worthwhile.
2. If You Default, You Can Lose A Vital Piece Of Equipment
The downside to having the equipment you purchase serve as collateral is that it’ll be the first thing your financer comes for if you default on your payments. If that equipment is vital for your operations, you may have a problem.
3. Equipment Vendors Want To Give You Financing
Recognize this one? This can be a pro, for sure. But as convenient as a captive lessor can be, you should also be prepared for extremely high-pressure sales tactics from them. They lose very little by bullying you into a lease you’re not prepared for.
4. Your Startup May Not Have That Much Cash
If you had large chunks of money to throw at equipment, would you be looking for financing in the first place? While we’re talking about the difference, say, between 15% and 25%, that may be a lot for a company without steady revenue.
5. You Need To Know What You’re Doing
Leasing and returning equipment can make fiscal sense, especially once you factor in tax optimization, but this isn’t a game for beginners. You’ll need to be very familiar with the type of equipment you’re buying, tax codes, and prevailing market values to get the most out of shorter-term leasing.
What You Need To Qualify For Equipment Financing
If you think equipment financing is the right option for your startup, you’ll want to be prepared when it comes time to fill out your application. First, you’ll want to know what your credit score is. Credit scores aren’t always a make or break for equipment financing, but you’ll have a much easier time with good credit than you will with poor. You’ll also want to have the standard information financers expect for loan applications. These include things like:
- Legal documents and licenses
- Bank statements
- Tax returns
- Statement of owner’s equity
- Business history
- Income sheet
You’ll also need to provide information about the product you’re buying and who you’re buying it from. Having that information on hand will greatly speed up the application process.
The good news is that equipment financing is one of the faster forms of financing you can get, with time to funding usually measured in days rather than weeks or months.
Does equipment financing sound right for your startup? Wondering where to go from here? We’ve got many more resources available for you!
Check Out Our Favorite Equipment Financers For Small Businesses
If you’re ready to find a lender or lessor to finance some equipment for you, you’ll want to take a look at our list of favorite equipment financers.
Don’t Think An Equipment Loan Or Lease Is Right For You? Take A Look At Other Financing Options For Startups
Did we talk you out of seeking an equipment loan or lease, but you still need financing? Check out our other financing options for startups.
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