Kicking off a new business can be an exciting yet daunting task. Some of the biggest challenges for new businesses are the start-up costs and getting enough capital together to get the business off the ground. A key expense in a business is the equipment that actually allows the business to function.
Equipment makes up the top three biggest costs in the business, the other two being manpower and rent. Depending on what business you are starting, equipment can take up at least 56% of your startup costs. Hospitality and restaurants, construction, and fleet make up some of the most expensive businesses to kick-off, with technology start-ups being a bit lighter on the pocket than these industries.
So, what do you need to know about equipment financing, and how can you work it into your strategic plan? We broke down how you can go about finding the right solutions for your equipment, which options would work best for your company, and the advantages and pitfalls to watch out for when acquiring new equipment. In particular, we are going to be unpacking equipment leasing and how it can benefit your company.
Take Your Finances Into Consideration
The first thing you are guaranteed to look at is just how much you have to spend on equipment. Being a new business or start-up, your capital is most likely going to be somewhat limited for large purchases. The working capital that you do have in hand should be used for day-to-day operational costs like your rent and wages and in case of unexpected expenses and drops in initial cash-flow.
Take into consideration the impact that COVID-19 had on businesses globally. Many businesses did not have enough working capital in reserve for the halt in income. This meant that their day-to-day expenses could not be met and excessive lay-offs were seen, while hundreds of thousands more shut their doors entirely.
Leasing allows you the option to not use this vital working capital for large expenses like equipment. It provides you the opportunity to work it in as monthly payments for a duration of time that are manageable and less financially risky to the business.
Do You Have A Credit History?
If you are looking at asking for credit from a financial institution, one of the things to keep in mind is your credit history. Due to the fact that you are a new business, the business is not expected to have a credit history that financial institutions can refer to to provide you credit. Leasing companies are less stringent when it comes to that.
Because they use the equipment as collateral, they are more likely to sign a contract with a new start-up business. Should the company default on the payment, they simply need to take the equipment back. This means less risk for them as lessors, but as a lessee, you will still need to continue honoring the contract.
Leasing companies are also more likely to take the business owner’s credit history into consideration when signing the contracts. This provides more security for the lease for both parties, and can also lower the interest rates of the monthly lease payments. Remember, the more risk you are, the higher the interest you are likely to pay.
Work Out Your Options
The next thing to look at is what actual equipment financing options you have available to you. Much of this will be determined by what kind of equipment you will be needing. If you are looking for equipment with a long lifespan, you will be looking at a totally different option than you would be for equipment that becomes redundant quickly. If you would also like to eventually own the equipment, there are also options in leasing for that.
Let’s look at an example. Things like printers and laptops are office equipment with a useful lifetime of around two years. After that, they start to become redundant as technology evolves and more sophisticated and useful versions are launched. Buying this equipment will, in the long run, simply cost you more as you will be replacing the equipment frequently. You will also have to dispose of the equipment correctly, which can also be a cost burden to you.
In these cases, operating leases could be your best option. An operating lease is a contract in which a lessor provides the lessee equipment at a monthly rate for a set duration of time, after which, the equipment is returned. The lessee can choose to upgrade at the end of the term, cancel the contract completely, or, if need be, re-lease the equipment.
A capital lease, on the other hand, is more suited for equipment with a longer lifetime value. These leases usually come with a residual, or in some cases, a $1 buy-out in which the lessee can take over ownership of the equipment. This is one of the less risky, and most affordable way to eventually own the equipment you need to operate your business.
What Extra Costs Can You Afford?
When it comes to equipment, you need to take other costs into consideration, further than just the overall outlay of what it will cost. Equipment will come with a plethora of extra costs that you need to take into consideration when signing a lease. Take maintenance, insurance, licensing fees, transport fees, import fees, and even training into consideration. These are all associated costs that come with the purchase of equipment.
Equipment financing can take some of those risks off you. In operating leases especially, where the lessor will always own the rights to the equipment, these costs will be factored into the lease and covered by them.
Think back to that printer, for example. The leasing company will be responsible for the regular maintenance and repairs of the printer, as well as the insurance of the equipment. The lease will include the leasing company delivering the equipment and providing a consultant to train your staff on how to use the new printer.
It might differ in capital leases, however. Because you, as a lessee will eventually be owning the equipment, you could be responsible for these costs. The insurance and maintenance will most likely be your responsibility throughout the duration of the term. However, if you can, you could potentially negotiate them to be included in the terms for a period of time. Leases with maintenance plans added on is the optimal equipment financing option for most companies looking to acquire equipment.
How Will It Impact Your Books?
This is a key aspect of equipment financing and choosing the right option for your business. If you purchase new equipment cash, you will be reporting it differently on your financial statements than if you are financing it.
Cash purchases are recorded as an asset on your financial statement and will be recorded as a debit and credit of the same amount. But, because you are the sole owner of the equipment, and it will be generating an income for your company, you will need to take the depreciation of the equipment into consideration. Say, for example, you are purchasing a truck with cash to start your fleet management business. Vehicles and trucks have a five-year lifespan; so divide your purchasing amount by five and include that on your financial statements as your depreciation amount
Leases are completely different and will have less impact on your balance sheet. Operating leases, in particular, are less risky. Because you will not be owning the equipment, it will not be recorded as an asset. It will rather be recorded as a business expense on the financial statement and expensed on the income statement. So, think of a lease as rent, which is recorded similarly. You will not need to take the depreciation of the equipment into consideration either and impacts both the net income as well as the operating income of the business.
Think of Taxation and Future Financing
Leasing comes with extraordinary tax benefits. Because they are recorded as expenses to the company, you can claim back from tax for your equipment financing. Operating leases, in particular, are recorded as “ordinary and necessary” business expenses, and can be written off to tax.
Because an operating lease is not recorded as an asset and because it is a debt for the business, that debt is fully tax-deductible. If you go further, the interest on your lease can also be written off. So, before you simply jump into a lease agreement, get some advice from a tax consultant and work out the best agreement with the lessor. You might find that most of the financing for your equipment can be written off.
Lastly, consider the ramifications of new equipment when it comes to investors and future lines of credit. Remember, credit providers and investors will be looking at your financial statements to determine your risk and creditworthiness. Leasing allows more room for future credit lines in the future. Investors will also determine that the monthly expense of equipment is less risky for them and will most likely be more open to investing in you.
The last thing you should take into consideration for your new business is who you choose as your equipment financing company. Because the equipment is going to play a large role in your business continuity, as well as be a long-term expense for you, you will want a company that will work together with you. Financing companies need to be considered partners rather than just lessors. You will want them to take your unique business needs into consideration, ad structure a deal that suits you.
They will also need to be reputable and experts in their industry and be able to advise you on any pitfalls and challenges that you might come across. Knowing the trends and fluctuations in the market will also be important as they might pose a risk for you, so get someone on your side to make sure you make the right financial decision for your business.