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It can be a thin line between success and failure for a small business. Having the right equipment can often make the difference.
Equipment can be very expensive so it’s common that small business owners will need outside financing to afford it. Here are some tips to make the best decision for your specific situation.
Loan or Lease?
You’ll first need to decide if it makes sense to either lease or purchase the equipment. There are some benefits to leasing in that you typically don’t need a down payment, which is beneficial when money is tight. At the end of the lease, you can either return the item or purchase it when the principal is paid in full. A general rule is that leasing may be preferable for equipment that you would replace in less than two years.
Buying is usually the better option if the equipment will be used for more than two years without requiring replacement or upgrade. By purchasing the equipment, you gain equity and potentially benefit from tax advantages such as depreciation. Additionally, your monthly loan payment can be considered as an operating expense, which can also benefit you at tax time.
You can also sell it if you find you don’t need the equipment, whereas with leasing, there can be high costs to get out of a lease early.
If you decide to take a loan to purchase equipment, be aware of related costs such as fees, delivery and freight charges, and taxes. Lenders will have different standards as to what is included in the loan and what is your responsibility.
Equipment Loans from Traditional Lenders
Generally with major banks, an equipment loan will cover about 80% of the total purchase price, so you will need to put down 20%. While you will own the equipment upon purchase, it is considered collateral so if you cannot repay the loan, the lender will take possession.
As with all major bank small business loans, they are not easy to get, with an approval rating of about 20%. Major banks have also veered away from certain industries, such as restaurants, deeming them too risky.
For the most part, major banks are not keen on making loans for small amounts and you’ll need an excellent credit score. Frequently, small businesses must be at least three years old and the documentation requirements can be burdensome. However, it may be worthwhile, given the lower interest rates, compared with other options.
The US Small Business Administration (SBA) 504 Loan or Certified Development Company (CDC) program provides financing for the purchase of fixed assets, such as equipment and machinery. This program works by distributing the loan among three parties. The small business owner puts down a minimum of 10%, a conventional lender (typically a bank) puts up 50%, and CDC puts up the remaining 40%. CDCs are non-profit corporations that provide loans to encourage the growth of small businesses in their local communities.
Note that these loans are targeted for equipment or machinery that have a minimum of a 10-year lifespan. Also, office equipment and computers purchases are not eligible for this program.
Another popular option for equipment loans are alternative lenders, such as BFS Capital. This option is particularly attractive for small business owners who are just starting out; those who require a smaller amount; owners who have low credits scores or those who need a decision quickly. Alternative lenders are often more flexible in terms of making loans to small businesses in a wider variety of industries, including those identified as too risky by many major banks.
Whereas major banks and even the SBA loans often have high minimum loan amounts, BFS makes loans from $5,000- $500,000.
BFS focuses loan decisions based on the small business’ cash flow. That means it is possible for the loan to cover 100% of the costs and all soft costs if the applicant is eligible; however, the interest rate will likely be higher than with a traditional bank or SBA program. But if those other options don’t meet your situation, an alternative lender may be the best solution.
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