Ask These Five Questions When Financing Your Equipment and Software
by Brian Bjella on Sunday, June 01, 2014
Many contractors, both small and large, finance their equipment and software rather than purchase with a lump sum payment because of the cash flow benefits this practice can bring to their businesses. In fact, according to the 2013 Bureau of Economic Analysis measurement of U.S. Gross Domestic Product and the Equipment Leasing and Finance Foundation, $0.56 of every dollar spent on equipment and software in the U.S. was financed. That’s $827 billion in 2013. Equipment financing is a major source of capital for the business sector and a growth engine for the U.S. economy.
Financing can be a growth engine for your contracting business, too, especially if you want your purchased equipment or software to pay for itself as it is being used. When you compare this capital purchase to the hiring of an employee, you want both to earn their keep over time. A good analogy would be giving your employee an entire year’s salary on day one.
If you take the financing route, know that some leases (e.g. dollar buyout) and all equipment finance agreements are eligible for favorable tax treatment when it comes to the Section 179 accelerated depreciation benefit. In nearly all cases, you can depreciate the entire amount of the equipment/software in year one, as opposed to writing it off over a five-year period. Of course, talk to your accountant or tax adviser about your specific situation. The write-off amounts have varied from year to year. At the time this issue went to press, the amount was $25,000.
If you’re not paying cash for your purchase, your other two options are to use a bank or a financing company that specializes in your industry. If you’re using a finance company, odds are your equipment vendor made the introduction. Most vendors and manufacturers have one or two financing companies they work with to help sell their equipment or software.
When given the option to finance, ask these five questions first to ensure you are making the smartest choice for your company.
1. Is the financing company a primary lender?
Many types of lenders are available, so know what kind of lender you are dealing with. Is it a broker, a bank-owned or ?publicly traded finance entity, or an independent finance company? Brokers typically obtain money from other lenders to process their transactions. They add commission/points to your financing and sell it to another financial institution.
Their rates are generally higher, and they have no control of your contract once it is sold to the financial institution. Bank-owned and publicly traded finance companies are prevalent in most large industry segments including construction. Banks are fairly aggressive in acquiring assets and will typically offer the lowest rate.
With the size and regulatory constraints some banks are under, they often are challenged to provide flexible and customized solutions, and service levels may suffer. Regardless of the type of finance company you are working with, they can all provide a valuable service in helping you acquire your equipment. Ask the questions up front to help set your expectations of your finance experience.
2. What is the rate?
All lenders in the construction equipment and software lending space are going to offer fairly similar rates. For example, on a $25,000 transaction, the monthly payment could vary by $10-20 per month. Be wary of the lowest rate, because the lender may seek to make this up with other fees and charges. Excessive late fees or limited grace periods, interim rents, down payments, security deposits, conversion and “evergreen” clauses are just a few ways that a low rate contract can actually end up costing you more in the long run. In addition, companies use various methods to quote a rate that will make them look much more favorable, but the rate actually may be higher. If the deal seems too good to be true, ask more questions and compare the actual monthly payment regardless of the quoted interest rate. In addition, look for a company that values their relationship with end customers as much as they value their relationship with equipment suppliers.
3. What are my payment options?
This is a good test to see how well the finance company understands your market. More experienced finance companies offer greater payment flexibility. Most of the time, you will be given a payment schedule for 12, 24, 36, 48 or 60 months—the longer the term, the lower the monthly payment. But if your business has seasonal variation with greater cash flow in high-season months and leaner cash flow in off-season months, you’ll want to know if the company has a seasonal payment program. Some may even offer a skip-payment program that schedules zero payments during certain months of the year. Some programs even offer the flexibility of no payments for the first three or six months to help you start earning returns on new equipment.
4. Does the proposed financing provide tax benefits?
?Every company’s tax situation is different, but businesses follow some basic principles when financing. Generally, accounting for a $1 buyout lease, equipment finance agreement or loan allows you to depreciate the asset over time and/or be eligible for accelerated depreciation under the Section 179 deduction. The vast majority of finance arrangements is on balance sheet and depreciated accordingly.
If you were to buy an asset using a Fair Market Value lease or rental agreement, through which the ownership of the equipment remains with the lending company until a purchase price is negotiated at the end of the term, then this could be considered an operating lease or off-balance sheet.
You may lose the tax benefits of depreciation, but you could possibly gain expense treatment for the monthly payments. If you rely heavily on the asset, determine the cost to purchase the asset at the end of the agreement so you aren’t surprised. As always, consult with your tax accountant on what structure is best for your company.
5. Is the company reputable?
The commercial leasing and finance industry is largely unregulated, resulting in a wide array of business practices that would be detrimental to the business owner. Your best bet is to ask for testimonials and references. Take note of how long the company has been in business. A simple Google search may provide you with plenty of useful information regarding the reputation of the company. The Better Business Bureau is also a great free resource you can use to examine the fairness of the company you’re dealing with. Always get a quote in writing, and make sure your contract is representative of the deal that was presented to you. If you see or hear any inconsistencies, move on to another finance source—hundreds of highly reputable companies work in the industry.
Financing can be a highly efficient and effective way of obtaining new equipment while managing your capital ?budget and cash flow. Knowing who you are working with, asking the right questions and reviewing your contract will help you avoid unpleasant surprises in the future.
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Reprinted with permission from Construction Business Owner.