Almost every operating business eventually needs equipment it would rather not pay for in cash: a fleet of trucks, a production line, construction machinery, medical or technology systems. There are two broad ways to finance it, and the right one depends on how long the business will use the asset and what it wants at the end.
The equipment loan
With an equipment loan, sometimes called an equipment finance agreement, the business owns the equipment from day one and the lender takes a security interest in it. The lender files a financing statement under the Uniform Commercial Code so its claim on the equipment is public. Payments repay the full cost plus interest, and at the end of the term the business owns the asset free and clear.
The lease
With a lease, the lessor owns the equipment and the business pays to use it. What happens at the end is set at the start, and it is the most important term to understand:
- Fair market value lease: lower payments, with the option to buy at fair market value, return the equipment, or renew. Suited to equipment that becomes obsolete or is replaced on a cycle.
- Nominal purchase option lease (often called a $1 buyout lease): payments cover essentially the full cost, and the business buys the asset for a nominal amount at the end. Economically close to a loan.
- Fixed purchase option lease: a set buyout, often a percentage of original cost, agreed up front.
- TRAC lease: used for titled vehicles such as trucks and trailers, with a residual value adjusted at the end of the term.
How to choose
Start with the asset’s useful life and your plans for it. If the business will run the equipment for most of its life, owning it, through a loan or a nominal buyout lease, is usually the better economics. If the equipment will be replaced in a few years, or technology moves faster than the payments, a fair market value lease keeps the business flexible and shifts the residual risk to the lessor.
“The end of the term is decided at the start. Read that clause first.”
Accounting and tax treatment differ between structures, and the rules changed meaningfully for lease accounting in recent years. Most leases now appear on the balance sheet. Talk with your accountant about how a specific structure will be reported and taxed before choosing one; this article is not tax or accounting advice.
What a lender or lessor looks at
- The equipment itself: type, age, condition, how it is used, and what it would sell for
- The business’s cash flow and how the equipment contributes to it
- Time in business, credit history and existing debt
- For vendor programs, the manufacturer or dealer relationship
- Insurance on the equipment, naming the lender or lessor
Questions to ask
- Who owns the equipment during the term, and who files what?
- What are my options at the end, and how is any purchase price set?
- What are the return conditions if I give the equipment back?
- Can I add equipment under the same agreement as the business grows?
- What happens if I want to pay off early?
For general information only. This is not an offer or commitment to lend, insure or invest, and not legal, tax, accounting or investment advice. Terms, availability and eligibility vary and are subject to credit approval and applicable law. Fortuneo Redux Reinsurance, Ltd. and Fortuneo Manens Life & Annuity Company are planned entities and are not licensed.