Leasing or financing equipment is a great way to expand and grow your business, but how does equipment leasing work?
Setting up a successful business is very expensive. You need space, people, and equipment. Regardless of whether you’re manufacturing clothes, processing raw materials, or providing IT services, any new business needs the right tools for the job. And established companies need new tools, to replace outdated or broken ones, keep up with the competition, or innovate and grow vertically.
But not every company has the working capital needed to invest in their equipment, especially in a fresh post-pandemic economy. Unless you’re Amazon or Walmart, chances are that you’ve been hard hit by the virus as most other companies have, and even the once deep pockets have become considerably shallower.
It’s times like these where credits and equipment financing become crucial to survival. As the economy continues to recover, many businesses are picking up steam and taking risks to secure capital in the long-term. Equipment leases are one way of financing a new investment in your business without completely breaking the bank.
Equipment leasing involves buying the right to use certain equipment (by paying rent on it), but not outright own it. Once the lease is over, the equipment goes back to its owner. Equipment leases will continue to be an important part of these strategies, helping companies replace old equipment or acquire new equipment with a fraction of the upfront cost, while remaining financially flexible.
Leasing vs. Buying Equipment
The age-old question regarding equipment leasing is whether it’s better than taking out a loan to buy the equipment, or just buying it outright. And as with most things, the right answer depends on the circumstances at hand. Equipment leasing is an ideal choice in cases where:
- Equipment needs to be regularly upgraded and swapped out, at a rate comparable to most leases.
- The cost of new equipment is staggering, requiring either a significant portion of a company’s working capital, or a loan.
- It simply isn’t feasible right now to pay for equipment outright.
- You will only need the equipment for a few years.
Aside from the major difference of owning it in the end, equipment leasing is like equipment loans. You determine the rates and terms and make monthly payments until the end of the lease, at which point the equipment is returned.
There are usually certain stipulations to entering an equipment lease – the equipment cannot be destroyed or returned in disrepair, for example, and usually needs to be maintained (and eventually returned) with parts from the original manufacturer. On the flipside, leasing is typically cheaper per month and takes much less time than paying off a loan. There are also certain tax benefits to leasing, including the ability to write off the lease payments as a business expense, which makes it a tax credit. Some leases are written to give businesses the option of paying the remainder of the equipment’s value at the end of the term to obtain it outright.
On the other hand, equipment financing (through a loan) is cheaper in the long run, especially if you end up paying the rest of the equipment’s value to buy it outright at the end of your lease anyway. This means the choice between the two ultimately boils down to whether you plan to keep it past its term.
Obviously, choosing to lease equipment also means needing to find new equipment to lease before the ongoing term runs out (or else you’ll find yourself without any equipment for a few days or weeks). Leased equipment also does not count as a business asset. Now that we know what it is, let’s explore how equipment leasing works.
How Does Equipment Leasing Work?
So, how does equipment leasing work? To lease equipment for a new business, you need the right partner. Leasing agreements are drafted with leasing companies that specialize in loaning out equipment to businesses in need. For the right price, that is.
Because leases don’t involve full ownership and monthly payments tend to be smaller than those of a loan or other traditional financing options, the qualifications for a lease tend to be a little laxer than those of a loan. However, the basics still apply: the older your business, and the better your credit history with other creditors, the better your terms.
To that end, the exact terms are between the lessor and the lessee. You can shop around for good offers, or work with the first financing company that provides you a good deal.
Different types of leases will have different terms. Some leases can be written up with the option of a lump sum buyout, at 10 percent or 20 percent, for example. But some leases can also be loans in disguise, giving you the option of buying the equipment for a nominal value of $1 at the end of the term.
One lease document can also be repurposed over a long period of time if a company plans to have a credit relationship with the lessor. This is known as the master lease, and may be amended via added exhibits to reflect new and old leases between the lessor and the lessee.
Consequences for using the leased equipment improperly or defaulting on payments can include repossession, or even government intervention in cases of illegal use.
Who Typically Leases Equipment?
Equipment leases may be taken into consideration when purchasing a new six figure sand blasting machine, CNC equipment, heavy equipment, cement mixers, industrial lumbar splitters. There are other types of leasing such as medical equipment leases such as MRIs and CT scanning equipment, outfitting a gym, setting up an entire office floor with workstations, and much more.
When the cost of the item is way out of budget, and you don’t need to own it for longer than the average duration of a lease, then leasing may be your best bet.
When Should You Avoid Equipment Leasing?
Avoid equipment leasing in cases where you expect to need that equipment for the next 20 years. Unless your lease is specifically written to include the terms and conditions of a buyout after the final month, you may be better off negotiating for equipment financing instead (which is often cheaper in the long run).
Regardless of if you are interested in equipment leasing or equipment financing, our team at Heartland Financial Group can help!