How to apply for business equipment financing: Eligibility, options, and essential steps

What is business equipment financing?

Also called equipment loans, business equipment financing is a type of business loan for purchasing machinery, technology, vehicles, or other tangible assets necessary for operating a business.

Whether you're a restaurant owner needing a new commercial dishwasher, a cleaning company looking to invest in a reliable van, or a medical office seeking to replace a broken ultrasound machine, small business equipment financing may be the solution.

Think of it as a financial tool for preserving working capital. Instead of a hefty upfront payment, equipment financing for new or established businesses spreads these costs over time, making them more manageable. It can be especially beneficial for startups and small businesses, helping them overcome budget constraints and obtain the tools they need to operate efficiently and stay competitive.

Are equipment loans and traditional business loans the same? Not exactly. Think of it this way: all equipment loans are business loans, but not all business loans are equipment loans. Traditional business loans offer broader applications, covering expenses like inventory, payroll, or marketing. Equipment financing, on the other hand, focuses solely on acquiring equipment.

How does financing business equipment work?

Existing or new business equipment financing can come from a variety of sources, including banks, credit unions, online lenders, equipment manufacturers, or specialized equipment financing for small businesses.

Before getting funding, you generally need to make a down payment, which may vary depending on the lender. When it comes time for repayment, businesses typically have the option to make regular payment installments over an agreed-upon term, which can range from months to several years.

The loan may likely accrue interest based on an agreed-upon rate. The interest can be fixed or variable, depending on the loan terms. The lender may also charge additional origination and documentation fees.

Normally, the tools purchased with an equipment loan serve as collateral until the loan is repaid. If a business fails to repay a loan, the lender may have the right to seize the asset to recover the losses. Equipment loans may also require a personal guarantee, making a business owner personally liable if the business defaults on the loan.

Types of business equipment that can be financed

Curious about the types of equipment that can be financed through an equipment loan? Here are some common examples across different sectors:

• Restaurant: Imagine you're opening a new café and need to outfit your kitchen. Equipment financing could cover essential appliances like commercial ovens, high-capacity refrigerators, and even those stylish espresso machines. Alternatively, maybe your existing restaurant needs to upgrade to a more energy-efficient walk-in freezer? An equipment loan can help you make that improvement without a major hit to your cash flow.
• Technology: For a tech startup, equipment financing could be the key to acquiring powerful servers, the latest software development tools, or laptops for your growing team. Similarly, an equipment loan can also help your established IT company upgrade its network infrastructure to handle increased demand.
• Transportation: If you're running a delivery service, equipment financing could help you purchase a fleet of new delivery vans or invest in GPS tracking systems to optimize routes and improve efficiency.
• Construction: Equipment financing is essential in the construction industry, where heavy machinery is a must. This could involve financing excavators, bulldozers, and other heavy equipment for large-scale projects. Meanwhile, a small landscaping business might use an equipment loan to purchase a new skid steer or replace an aging tractor to remain competitive.
• Manufacturing: In manufacturing, equipment financing can support the acquisition of advanced machinery, such as CNC machines, robotic systems, or specialized assembly line equipment. It could also help a small batch manufacturer purchase a new packaging machine to increase production capacity and meet growing demand.
• Medical: For healthcare providers, equipment financing can cover a range of needs, from diagnostic imaging machines like MRI scanners to specialized surgical tools. A dental practice, for example, might use an equipment loan to purchase a new X-ray machine or upgrade their patient chairs.

The best way to determine the types of equipment that can be financed for your specific business is to consult with a lender or financial advisor. They can provide personalized guidance and help you explore options that align with your needs and goals.

Pros and cons of financing business equipment

Equipment financing can be a powerful tool for businesses to acquire necessary equipment without breaking the bank. But like any financial decision, you should carefully consider the advantages and disadvantages before taking the plunge.

Potential benefits of equipment loans for small businesses

There are several potential upsides of startup business equipment financing or other forms of small business funding:

• Cash flow management: Instead of a massive upfront payment, businesses can spread the cost of the equipment over time. This frees up valuable cash flow for other essential operational needs, such as inventory management, marketing campaigns, or hiring new team members.
• Access to the latest technology: In today's rapidly evolving business landscape, having the right equipment can make all the difference. Equipment loans provide access to cutting-edge technology and equipment upgrades, leading to improved operational capabilities, increased output, and potential cost savings.
• Building credit: By consistently making payments on time, businesses can establish a positive credit history and improve their credit score. This can be invaluable for securing future financing and building trust with lenders.

• Tax advantages: Depending on the specific terms and your location, there may be tax benefits associated with equipment financing. For example, you might be able to deduct interest payments or depreciate the equipment's value over time.
• Flexibility: Equipment loans often come with flexible terms, allowing you to tailor the repayment schedule to your business’s cash flow and budget. This can provide peace of mind and make managing your finances easier.

Potential drawbacks of financing for business equipment

Some potential disadvantages of financing for business equipment include:

• Down payment requirements: Many equipment loans require businesses to make a down payment, which may be 10% to 20% of the total loan amount.

• Interest and fees: Equipment loans, like most forms of business loans and lines of credit, typically include interest charges and fees, which can increase the overall cost of financing.
• Collateral and personal guarantees: Since the equipment purchased generally serves as collateral for the loan, there may be a risk of losing the equipment if the business defaults on payments. Also, some lenders may require a personal guarantee from business owners, holding them personally liable for the small business loans.
• Depreciation: Equipment, especially technology, can depreciate in value over time. This means the equipment's value may decline while you're repaying the loan. In some cases, this can lead to a situation where the outstanding loan balance exceeds the equipment's current market value.

How to obtain business equipment financing

Ready to apply for equipment financing? Here are some general steps small businesses can follow:

Remember that these steps provide a general framework, and the specific process may vary depending on the lender.

Eligibility requirements for equipment financing

While the allure of new equipment is exciting, it's important to understand whether you're a good candidate for equipment financing. Lenders assess various factors to determine your eligibility and the terms they'll offer, including:

• Personal and business credit scores: Your personal and business credit scores indicate your financial responsibility. Lenders want to see that you're a reliable borrower who honors financial commitment. Higher scores unlock better loan terms and lower interest rates.
• Credit history: Lenders will review your credit reports for any red flags, such as late payments, bankruptcies, or collections. A clean credit history demonstrates stability and trustworthiness.
• Revenue and profitability: Lenders need assurance that your business generates sufficient revenue to comfortably handle the loan repayments. They'll review your financial statements (income statements, balance sheets) to assess your profitability and cash flow.
• Time in business: Established businesses with proven track records are generally viewed as less risky. Startups or newer businesses might face stricter requirements or need to provide additional documentation.
• Industry: Some industries are considered riskier than others. Lenders might have specific requirements or preferences based on what type of business you run.
• Down payment: The amount of down payment you can provide influences your loan eligibility and terms. A larger down payment reflects well on your commitment and reduces the lender's risk.
• Loan term: Your desired repayment period can also affect your eligibility. Shorter-term loans generally have lower interest rates but higher monthly payments.
• Collateral: The equipment itself serves as collateral for the loan, assuring lenders they have a safety net in case of unexpected circumstances. They'll assess its value and marketability, ensuring it holds its weight in the deal.

Equipment financing loan vs. equipment lease: Which is right for your business?

Once you've found the perfect piece of equipment, you have another decision to make: should you opt for an equipment financing loan or an equipment lease? Both options offer a pathway to the equipment you need, but each has distinct advantages and considerations.

Equipment financing generally involves obtaining a loan to purchase equipment, with the business eventually owning the equipment once the loan is fully repaid. For example, if you’re a restaurateur trying to purchase a new state-of-the-art pizza oven, equipment financing would involve making monthly payments to your lender. Once the loan is paid off, that gleaming oven is all yours — you can use it to continue cranking out pies, sell it, or trade it in.

On the other hand, equipment leasing can allow businesses to use the equipment for a predetermined period by making regular lease payments. In other words, you're renting the equipment for a specific period, enjoying its benefits without the long-term commitment of ownership. At the end of the lease term, you can return the equipment, renew the lease, or purchase the equipment.

Say you’re a tech startup that needs cutting-edge computers for your development team. Given that technology evolves rapidly, an equipment lease could be the perfect solution — you could lease the computers for a couple of years, and when the lease ends, upgrade to the latest models without the hassle of selling your old equipment.

While equipment financing can offer ownership and long-term investment, equipment leasing may provide flexibility, lower initial expenses, and the ability to access updated equipment. Ultimately, the choice between the two will depend on your business needs, budget, desired ownership, and equipment lifecycle.

Looking for more small business loan tips? Learn more about applying for a small business loan.