Running a small business is tough and come with long hours and lots of hard work. It is a continuous cycle of making calculated decisions based on assumptions with the hopes it will be the right decision for your business and drive it forward. When it comes to equipment financing and borrowing money for your business, you want to ensure you are making informed decisions and getting the right financial products for what you are trying to achieve.
Here are some common mistakes to avoid with regards to equipment financing and leasing for your business:
If you are going to be borrowing money to finance equipment for your business, you need to have a plan beforehand. The plan should ensure how and why you are going to borrow the money and use it in your business, what return you are going to get on borrowing the money, and how you are going to pay it back. As part of your business planning, you should be forecasting out growth and anticipate expenses as your business grows and matures. The longer the time in business, the easier forecasting becomes and you start to see trends and cycles within your business. A best practice may include have an annual plan broken down to quarters and evaluated weekly and monthly to gauge performance and progress against what you are looking to achieve.
Every business will have financially good and bad times, which is why it is very important to manage your finances wisely during the good times. Some folks do not do this very well and end up in a very bad fiscal situation. So bad in fact, they need to choose between layoffs, paying bills or closing down. So, they decide to get a business loan. The only problem with that is, unless you address the problems that lead to you cash crunch in the first place, you will end up in the same spot you were in. That is unless you make a plan to increase your return on the investment. Understanding that loans are not free money and must be paid back with interest on top. Do not take out a loan just to pay your bills. Only borrow money when you have a plan of how to pay it back, and have it make money for you.
An equipment financing and leasing contract, and its associated terms and conditions typically are pretty straight forward. However, like anything else it pays to do your homework and understand what you are committing to and ensure it is aligned with your business goals. Make sure you fully read and understand all of the terms and conditions laid out in the contract. Such as, length, early cancellation fee, payment schedule, insurance requirements, administration fees, etc. If there are any grey areas in the contract make sure you ask questions and do not sign until you have the answers.
Here is a breakdown of some of the major terms and conditions that could impact your business:
a. Buy-Out & End of Term
There are two main types of equipment leases you will come across. The first is the nominal purchase option lease and the other is the stretch lease. The nominal purchase option lease has a specified buy-out that is executed automatically following the last payment and the lease is terminated. Typical buy-out options depend on the individual lender but range from $1 to $750.
The second lease option is the stretch lease. When the stretch lease comes to the end of the term and the purchase option is due, you are responsible to notify the leasing company of your intent to execute the purchase option. The notice should be given 60 to 90 days before reaching the purchase option date. If you fail to notify, the lease will then go into the stretch period and your monthly payments will continue on as a “rental payment”. Most lenders leave the purchase option available to you, but none of the “rental payments” will be counted towards the purchase option amount. The purchase option it typically 10% of the original pre-tax equipment cost; in other cases it could be fair market value (“FMV”).
It is recommended to pursue the nominal purchase option lease structure as your lease will terminate automatically and there will be no surprises come end of term. If you have been advised otherwise or have decided to choose the stretch lease option, be sure to make a journal entry to notify the lessor of your intention to exercise the purchase option when due.
b. Terms of Repayment
Equipment financing and leasing terms typically range from 18 to 72 months with the average term being 40 months. It is important to understand, that other re-payment terms may be available other than those that have been presented to you. As you evaluate your terms and payment options, you should ensure your term is well matched to your cash flow without restricting your operation. If your business is seasonal, most leasing companies offer payments that match your busier periods and lower payments when your business is in the off-season. Other terms may include three months of no payments at the beginning of the lease. This is good if the equipment is for a new offering or service as it allows you to build up a client base before you start paying for the equipment.
If you don’t see the term and payment that matches your business, it is important to ask to see what other options may be available and not just take what is presented to you. Most equipment leasing companies are great at structuring transactions to fit the needs of their clients.
c. Administration Fees
Nearly all equipment financing companies charge a one-time administration fee at the time of the lease start. These fees can range from as little as $50 to $750 for larger transactions. Administration fees are also known as “Registration Fee”, “Processing Fee”, or “Documentation Fee”.
Be sure that the fee doesn’t seem absurd for the amount you are borrowing. As a general rule of thumb, the administration fee should never be larger than the monthly payment amount and it should only be a one-time charge. The fees are said to cover the application, documentation, and government registrations. If you feel your administration fee seems high, challenge your leasing representative to do better as most fees are negotiable.
Almost all leases need to be insured. Some equipment leasing companies require insurance confirmation upfront to start the lease agreement and others will not require insurance to start the contract but will require it within the first 30 days.
It is recommended on all leases to provide confirmation of insurance upfront as if you fail to do so, you will automatically be enrolled in the leasing company’s insurance program at an additional monthly cost.
e. Additional Fee’s & Charges
All equipment leasing companies have additional fees that may be applicable to the lease contract. These are typically noted as a “general fee” clause in the terms and conditions of the lease contact. Some of the most common additional fees include:
Note that some of these fees may be negotiated and many may not apply to every lease contract, but in any case, as a consumer you should be aware that they exist and by signing a lease contract, they could apply to you.
Equipment financing and leasing is widely used by all types and sizes of business to acquire equipment they need to run and grow their operations and that is why it is important to find the best equipment financing company to work with and spend some time researching which partner may be best for you. Just like any other business, equipment financing companies tend to be lean into certain market segments better and thus have a better understanding of what their customers may require.
Here are some questions and places to start while researching prospective equipment financing companies:
Once you have some names of some equipment financing companies to evaluate, be sure to investigate the following before making a final decision:
Don’t borrow money if you don’t need the money or have a plan for it. Borrowing money should be treated like any other tool you use in your business; it has a defined purpose to get a job done that is much bigger than itself. Borrowing money or financing equipment because of a promotion is not a good enough reason to deviate from your business plans. Often offers of 0% or don’t pay for 90 days, etc. are tempting but getting something, you don’t need can ultimately be a costly mistake and stressful on the business and cash flow. Many times, offers are repeated so be mindful of this and when the timing is right you can borrow or purchase at that time.
Having the right partners and advice can be crucial to advising your business on what type of financing products you should be using to finance equipment. There are other financial instruments available to finance equipment for your business, but they may not necessary be what is best. Other financial considerations could include business loans, lines of credit, and bank loans, but by far, equipment financing and leasing is the most prominent at the dealer level where you are actually purchasing the equipment from. The equipment dealer should be knowledgeable about your business, your needs, and any financial options that are available to your business for financing the equipment they sell.
You wouldn’t tow your boat with a motorcycle; you would use a truck, and you wouldn’t use a raft to send shipping containers across the ocean. So why would you use personal financing debt to acquire equipment for your business?
Using the wrong financing product to finance equipment for your business can have negative impacts on you and your business.