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How to Finance Equipment for Your Small Business

Rebecca Lake

Buying equipment for your business -- whether you're purchasing it for the first time or upgrading -- can get expensive. Financing may be necessary to purchase what you need.

Small business equipment financing options include:

-- Term loans

-- Specialized equipment loans

-- Small business lines of credit

-- Small business credit cards

Comparing the different equipment financing options can help you determine which one best fits your business needs.

Benefits of Financing Equipment for Your Small Business

"New equipment is a situation where small businesses commonly seek financing," says Bernardo Martinez, managing director at Funding Circle U.S., a platform that connects investors with businesses seeking capital. "This allows them to preserve their working capital for other strategic purposes, and in some cases, the equipment may even help generate new revenue for the business that could help offset the costs of financing."

Financing also could help you remain competitive within your business niche if it allows you to purchase the most up-to-date equipment available. Depending on the lender, you could tailor repayment terms to fit your business's cash flow and revenue. And you may be able to finance 100% of the purchase with no down payment.

[Read: Best Small Business Loans.]

Term Loans for Equipment Financing

If you need to buy equipment for your business, a term loan lets you borrow a lump sum of cash and repay the loan over a set period of time at a fixed or variable interest rate. The fixed repayment schedule associated with term loans can make managing cash flow easier while balancing other capital needs.

"What we often see are businesses that want to purchase equipment, in addition to making other investments in their business, like hiring or marketing," Martinez says. He uses the example of a restaurant owner who wants to replace kitchen equipment while launching a new marketing campaign to prepare for the busy season.

"Term loans are good for this purpose because the funds can be used beyond the equipment itself," Martinez says. "And you still get the fundamental benefits of term loans: larger funding amounts, longer repayment terms, reasonable rates and a single, predictable monthly payment."

Term loan specifics can vary from lender to lender, but typically these loans offer:

-- Repayment terms from six months to five years

-- Borrowing limits up to $500,000

-- Interest rates ranging from 7% to 36%

Additionally, term loans from online lenders can offer fast funding, with the loan proceeds available as quickly as the same day you're approved.

Generally, online lenders and banks will qualify your business for a term loan by considering:

-- Business and personal credit scores

-- Time in business

-- Annual revenue

-- Business plan

-- Earnings statement

-- Balance sheet

-- Business and personal tax returns

As far as credit ratings go, you can get approved for short-term loans with a personal FICO score as low as 500. But keep in mind that your credit score can influence how much you're able to borrow, your interest rate and loan terms. The better your credit score, the better your loan terms are likely to be.

Choosing the right loan term is critical when financing equipment.

"Selecting the right term is all about cash flow," says Michael Wamsganz, executive vice president and business banking division head at Huntington National Bank. "You need to be thinking about this for the short and long term, as being able to anticipate what might be around the corner from an expense perspective is very important."

Ware says business owners must weigh a trade-off. "On one hand, a longer loan term will result in lower monthly payments," he says. "On the other hand, a term that is longer than the useful life of the asset will result in payments still having to be made in the future, after the asset is no longer of value."

Specialized Equipment Loans

Equipment loans are just what the name suggests: loans exclusively used to purchase equipment for your small business. Banks and online lenders offer these loans.

Equipment loans are repayable over a fixed term, with terms ranging from one to five years. Borrowing limits can be as high as $5 million, with interest rates as low as 7.5%.

[Read: Best Bad Credit Loans for Small Businesses.]

Compared with other financing options, equipment loans most closely resemble term loans, Wamsganz says.

"With equipment financing, the piece of equipment being purchased serves as the collateral," he says.

Tom Ware, senior vice president of analytics and product development at PayNet Inc., a small business credit-rating company, says the collateral structure of equipment financing is particularly advantageous "because if the borrower can no longer make payments, the lender can still get repaid by selling the collateral."

"This benefit to the lender translates into a benefit to the borrower in terms of lower interest rates, a greater amount of credit and longer transaction terms, versus other methods of financing," he says.

Another advantage of collateral-backed equipment loans: You may be able to qualify if you have a newer business or a lower credit score.

For example, you could be approved if you've been in business at least 12 months, have $50,000 or more in annual revenue, and a credit score of 650 or higher. And, in some cases, you might qualify with a score below 650 if you can demonstrate solid cash flow and positive revenue.

Business Line of Credit

A business line of credit is an alternative to conventional term loans and equipment loans and can be tapped repeatedly. Business lines of credit are revolving debt, meaning you can draw against them as needed if you have available credit.

Compared with a loan, a line of credit usually has a variable rather than fixed APR. Collateral isn't required for unsecured lines of credit. And because they're revolving lines, you have the flexibility of using them to purchase equipment or covering other business expenses.

A business line of credit could also be easier to qualify for than a business loan. For instance, you may find lenders that will approve you for a line of credit with a 500 credit score.

SBA Loan Guarantees

Some loans for equipment financing may be available with an SBA guarantee. With the guarantee, the SBA promises to pay back a portion of the loan if you can't, reducing risk for the lender and potentially making loan qualification easier for businesses.

The SBA offers several loan programs for small businesses that can help cover equipment purchases. Those include:

-- 7(a) loans

-- Certified development company/SBA 504 loans

-- Microloans

SBA loans set generous borrowing caps of up to $5.5 million, allowing you to finance large equipment purchases. Depending on the type of loan, repayment can be extended up to 20 years. However, lenders may set shorter repayment terms and lower maximum loan amounts.

This table highlights the differences among SBA 7(a), CDC/SBA 504 and microloans:

Loan Program Loan Amounts Repayment Terms
SBA 7(a) loans Up to $5 million Up to 10 years, or more for real estate
CDC/SBA 504 loans Up to $5.5 million Up to 20 years
SBA microloans Up to $50,000 Up to six years

SBA loans have specific guidelines you need to meet to qualify. The main requirements include:

-- Maintain for-profit status. You must own a U.S.-based, for-profit business in an eligible industry.

-- Meet SBA size standards. Your business has to qualify as a small business based on the number of employees or revenue.

-- Have invested equity. The SBA requires business owners to invest time or money into the business.

-- Exhaust your financing options. Businesses must show they can't get funds from another lender.

Lenders typically have their own set of requirements for approval, in addition to basic SBA requirements. They usually consider criteria, including:

-- Time in business

-- Personal and business credit scores and reports

-- Personal and business income tax returns

-- Business financial statements and business plan

-- Business and personal bank statements

-- Asset valuation

Some SBA loans require collateral and may use the equipment itself to secure the loan. The equipment must be professionally appraised to establish its value as a condition of loan approval.

In terms of timing, SBA loans may not be the fastest financing option for equipment, as the typical timeline for funding is 60 to 90 days.

Wamsganz says another potential downside is the fees you may pay with an SBA loan, which include guarantee or origination fees of up to to 3.75 percent.

[Read: Best Unsecured Business Loans.]

What About Business Credit Cards?

Business credit cards are another equipment financing option. Applications are typically less time-intensive than some business loans, you can take advantage of a zero percent APR introductory period, and you may save money if you're earning cash back, miles or points on the purchase.

But there are some drawbacks to consider. Credit cards could have higher interest rates than equipment loans, and the amount of credit extended to you is usually significantly less, Ware says. "That said, using a credit card is probably much easier and quicker, and if the amount is small, it may be a reasonable approach," he says.

Wamsganz says credit cards and lines of credit are better suited to covering short-term working capital needs. Like Ware, he says the exception is smaller equipment purchases, such as new computer hardware or software.

As you compare avenues for financing equipment, remember to read the fine print before you commit.

"Regardless of the type of financing you go with, it's important to understand how much you are really paying at the end of the day," Martinez says. He recommends understanding fees, penalties, interest and repayment terms before signing on the dotted line.



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