Factory Equipment: The Basics of Leasing and Financing
Factory equipment is an essential aspect of business, but what is the best way of financing and receiving new equipment? Here’s what you should know about leasing and financing options.
Whether you run a small business or manage acquisitions for a larger company, having heavy equipment break down can put a massive dent in your finances. Buying new factory equipment is expensive, and a long-term process that requires careful market research, negotiations, and scoping out the right vendors.
But for smaller businesses in particular, the prospect of purchasing equipment outright – especially in the middle of global manufacturing shortages and continued shipping difficulties – can appear tantamount to financial suicide. However, you do have other options. Aside from buying factory equipment outright, you can consider manufacturing equipment financing and leasing or rental options.
Even if you aren’t in dire need of an upgrade or replacement equipment, equipment leases and renting options can provide your business with immense flexibility, free up capital, and allow you to save the option of taking out a bank loan for other costs and obligations. Leasing options also let you reinvest your working capital into other repairs and maintenance costs, branding and marketing, hiring new talent, expanding your operations, and much more.
Leasing and Financing Factory Equipment
Equipment leases and equipment financing options are different ways to describe the same thing – a financial agreement with either a rent or buy option. Leases generally describe a long-term rental agreement, wherein you pay monthly for a set term length of a year or more, rather than a typical rental agreement which can be shorter.
Leases can be written to provide different terms and conditions, with some leases requiring that equipment maintenance costs and miscellaneous costs come out of the lessee’s pocket, while other leases include these costs on the lessor’s side. This flexibility can be a blessing – provided you negotiate a lease you are comfortable with.
Many factory equipment leases can be written to provide a buyout option at the end of the term. In this case, the lessee is given the opportunity to pay the remainder of the equipment’s worth at the end of the term to own it outright. This way, they can make use of the equipment while paying a lower monthly fee, earn a profit from their new equipment, and still make the decision to purchase it when the lease’s term comes to an end.
There are many types of factory equipment that are often available for lease on the free market, from CNC machines to manual metalworking machines, assembly line machines, industrial ovens or freezers, painting and coating setups, 3D printers, lasers, plasma cutters, and more.
Businesses can also utilize heavy equipment financing to get equipment needed around a factory and warehouse, including motor pulleys and crane setups, security systems, and forklifts.
Leasing, Renting, Buying, and Financing Explained
While the differences between leasing and buying are minimal, they do exist. Financing in general refers to any arrangement between a vendor or financial institution (the lender or lessor) and a buyer, lessee, renter, or borrower. In short:
- Renting equipment involves paying a monthly fee for its use.
- Leasing equipment involves paying a monthly fee for a set term. Leases have different privileges and benefits over renting.
- Buying equipment outright involves putting the money down to own it on day one. Most companies who don’t have a large amount of working capital take out a bank loan to buy new equipment.
- Financing equipment involves paying the loan directly to the vendor. The benefit of setting up financing with an equipment vendor or through a financial middleman is that the equipment itself neatly serves as collateral for the loan.
When buying factory equipment, many businesses may feel that they are better off leasing or financing new equipment, depending on their financial situation and their current needs as a company. It is critical to discuss these considerations with an accountant or legal advisor. This is not to constitute as legal or financial advice, but rather, help inform readers.
Equipment Leases vs. Loans
The main point of contention when discussing leases and other financing options is why one would choose one over another. What is the benefit in leasing versus taking out a bank loan, or a financing contract with the vendor themselves?
As always, the answer to that question is mostly related to financial liquidity – i.e. upfront costs, as well as opportunity cost. Bank loans are not necessarily easy to qualify for, and there may be other operating costs, repair costs, unexpected losses, and cash flow considerations where a loan from the bank would make more sense.
Because financing options exist for most types of factory equipment, it is almost always going to be better to utilize those options rather than take out a bank loan you could be using for something else.
Leases and financing agreements are somewhat interchangeable when designing a lease with the option to buyout equipment at the end.
In these cases, leases become the more attractive option for businesses who simply do not have the means to pay a higher monthly cost but need to replace their equipment to make a better profit. Leases without the option of buying the equipment are also ideal in situations where you tend to replace your equipment every year or so, anyway. Leases may also help both lessors and lessees realize better tax benefits than financing equipment to buy it.
It might make more financial sense in the long-run to lease certain types of factory equipment versus financing equipment for five to ten years, selling it, and starting a new contract. Factory equipment that generally has a set useful life. Take forklifts for example, you can lease a forklift for that period and replace it with a new lease thereafter.
Common Factory Equipment Leases Explained
While there are a lot of different types of factory equipment leases, all leases can generally be described as either capital leases or operating leases.
Capital leases are leases that end with you buying the equipment. Operating leases are not. Operating leases are also true leases. Aside from this major difference, there are also tax differences to consider. Most other differences between lease types are explained by changes in any given lease’s terms. Common lease types include:
- $1 Buyout Leases – Effectively 100 percent financing, but with the option to take or leave equipment at the cost of a nominal $1 fee. A common capital lease. There is no reason to pursue this type of lease unless you plan to own the equipment at the end of it. Also has the highest monthly costs.
- 10% Option Leases – Under this lease, the terms of the lease pay for 90 percent of the equipment’s value, with the option of buying the final 10 percent after the lease ends.
- Fair Market Value Leases – This is an operating lease wherein the lessee has the option of buying the equipment for the remainder of its FMV after the lease ends.
- Sale Leaseback – In this case, the lessee sells their equipment to a lessor for a lump sum of cash and leases the equipment while buying it back one payment at a time.
- And more.
Whether equipment leasing is the right choice for you depends on your options as a lessee or buyer, the kind of equipment you are leasing, your tax situation, and other factors. Always discuss your options with a tax and financial specialist before making large purchasing decisions.