Chalk it up to simple economic realities, but a capital expenditure requires quite a bit of forethought these days. This makes finding the best equipment financing for your business more important than ever, says Tim Evans, president of FirstMerit Equipment Finance.
“We tend to keep equipment around a lot longer than we have in the past,” Evans says. “It’s important that when you get that initial piece of equipment and you make your decision on financing that you are thinking long term, not just short term, and that you understand the value of that equipment to your business.”
Smart Business spoke with Evans about how to set up the best equipment finance agreement for your business, and what not to do when structuring the agreement.
What are some issues companies should consider when financing equipment?
Companies should think through the true economic life of the equipment. How long will you be able to use it in its current application? Can it be converted to some other capacity to lengthen the life of the equipment longer than it would normally be? Are there upgrades or refurbishments that could extend the life of the equipment?
How can companies determine whether financing or purchasing a piece of equipment is the right choice?
You can’t be short-sighted in how you use your capital today. We’re coming out of a recession, and many customers are asking for sale leasebacks because, prior to the economic slowdown, they tied up their capital in their equipment purchases. When you run into a down cycle like we’re in today, you need working capital to run your business. But when you’ve tied it up in your equipment, you’re out of luck.
Equipment financing and leasing is the way to go to avoid a shortage in working capital. If you have the ability to finance your equipment and keep working capital in your business, that gives you more flexibility. It’s very difficult to structure a sale leaseback 12 to 18 months after you paid cash for the equipment, because the equipment depreciates and its value will be a lot less at that point in time.
What should business owners look for when setting up financing agreements for leased or purchased equipment?
One of the biggest misnomers in the industry is to look for the absolute lowest rate for your equipment financing. Money is money, but when you are looking for equipment financing, you want to work with a partner who understands your business, and who understands the necessity of being able to do something different down the road if your situation changes. You need flexibility.
Often, companies get offered a below-market rate that looks great at the time they signed the deal. But what if they are two years into their five-year deal and they need to make a modification? When you go into that low of a rate structure, many times the flexibility just isn’t there because of the tight requirements in order to achieve the goals that the lessor established in the deal.
At FirstMerit, we look at it as an overall relationship. Our goal is to give you the ability to work within your business frame to make any necessary changes in how you are doing business if your situation changes.
You should look to work with a lessor that is flexible. If you just go with whoever is offering the lowest rate on the street, you’ll find that service and price don’t always go hand in hand. We will always be competitive, but we also pride ourselves on being a good service partner.
What are some typical equipment financing mistakes that companies make, and how can they be avoided?
The biggest mistake companies make is they aim for the lowest possible payment. Typically, that means you get the longest possible term, which can create a lot of issues down the road.
You might have an asset that won’t be of any use to you after five years. But you have a targeted payment in mind, and because of that you need an seven-year term. The structure of the lease, the potential buyout on the back end of the lease, whether it is a fair market value lease or a conditional sale — those are all issues you want to be aware of, because they are going to impact what happens down the road when you decide whether you want to buy that equipment or return it.
Another key point: make sure you understand the tax ramifications of your transaction. It may be beneficial to your company to pass any bonus depreciation on to the lessor (the bank) and do a true lease, because you could receive a lower payment structure. In this case, the lessor would take the depreciation benefits and then pass those benefits back to you in the form of a lower rate.
Always ask questions and make sure you read your documentation — especially the fine print. You don’t want any surprises down the road so make sure you read your documents thoroughly.
How can business owners determine whether an equipment lease being offered by their bank is a good one for their business?
There are three major components to consider. First, how long are you keeping the equipment? Can you utilize the tax benefits? If cash flow is an issue, is 100 percent financing more attractive than a conventional term loan where a 20 percent down payment may be required?
Tim Evans is president of FirstMerit Equipment Finance. Reach him at (330) 384-7429 or Tim.Evans@firstmerit.com.