I’m a small business owner and I need critical production equipment to improve speed, cost, and quality. I’ve looked into loans and leases but I’ve heard about Equipment Finance Agreements or EFAs. I heard these were just for large organizations, could an EFA be an option for me?
The answer to these questions is no and yes. No Equipment Finance Agreements are for businesses of all sizes, it depends on business economics and needs. So the answer to the question of could the EFA be a good option is yes.
A term loan and lease both provide substantial benefits and restrictions. The EFA equipment financing agreement sort of threads the needle to give you the benefits of both while avoiding the downsides of either.
What is An Equipment Finance Agreement
The ability to thread the needle between lease and loan is why EFAs have been gaining in popularity among businesses and lenders. Basically, an Equipment Finance Agreement document combines the loan, security agreement, and promissory note all into one document
An EFA can be used to finance vehicles or other potentially dangerous equipment as they reduce liability to the lender or lessor. But because they have other benefits lenders have been offering them for other types of equipment purchases.
Deciding Between A Loan or Lease
Is a loan the right thing or should I look at leasing the equipment? To help answer this question it is good to ask yourself or your team a few more questions related to the equipment needed.
Questions to ask to determine if a loan or a lease is the right option:
- Does the equipment hold its value?
- Will the equipment stay in use for many years Does it require frequent upgrades?
- Can it go obsolete prior to the end of life?
If your answer to 1 and 2 is yes, then a term loan leading to purchase might look like the best option. If you’ve answered yes to 3 and 4 then leasing might make the most sense.
But what if the answer is a combination. And on top of that, you have a cash flow problem, then the EFA may be the answer.
EFA Threads the Needle Between Loan and Lease
Both the EFA and term loan have characteristics that make them look very similar, but the EFAs have unique provisions that make them look like a combination of loan and lease.
Note: The definition of terms can be different depending on the drafter of the document you may see. Commonly, “lessor” and “lessee” or “lender” and “borrower” are used in these documents. But they will not be used interchangeably in the same document. In this article, we will refer to the lessor as the entity providing the funds and the lessee as the one that receives the funds.
Advantages of The Equipment Finance Agreement
Creates ownership
When the agreement is signed ownership is transferred to the lessee. This can provide tax benefits and reduce complexity in how the equipment is used.
Financing upfront to purchase the equipment outright
Similar to a loan financing will be provided to purchase the equipment and transfer ownership to the lessee.
Fixed finance charges rolled into monthly payments
Interest charges, finance charges are rolled into a fixed monthly payment. This payment is known when funds are provided and it will not change for the term of the agreement.
Equipment purchased as collateral for the loan
A big advantage of an EFA is the equipment that is purchased is used as collateral. For most term loans the lender will require some sort of personnel guarantee or other encumbrances to the business. That may limit the business’s ability to get additional funding.
Equipment is listed on the balance sheet as an asset
The Equipment Finance Agreement is not off-balance-sheet financing. So the asset and liability will show up on the balance sheet.
No restrictive covenants
With many loans, lenders put restrictions on the performance and operation of the business, or additional lending. Because the equipment is the collateral, there are no additional covenants placed on the business.
Preserve cash flow
In many cases, the Equipment Finance Agreement allows for negotiations that a standard lender is not permitted because of financial regulations.
This allows the business and the lender to work together to get the best agreement possible for both parties. This might include an agreement on the value of the asset at the end of the term and lower payments with a balloon payment at the end.
Sound investment
This can be a sound investment for the lender as it gives a guaranteed cash flow plus an agreed value at the end of the term. This cash flow is also collateralized by the equipment.
Keep equipment up to date
Depending on the agreement the equipment can be updated similar to a lease arrangement.
100% financing
Allows for one hundred percent financing of the equipment allowing ownership and depreciation to be realized by the lessee.
Speed, flexibility, convenience
This type of financing can often be closed quicker than a normal loan, and depending on the agreement can be quicker than a lease.
Tax advantages
Get the same benefit as if you had purchased equipment outright see Section 179 benefits of the IRS tax code allows businesses to deduct the full purchase price of qualifying equipment and/or software purchased or financed during the tax year.
That means that if you buy (or lease) a piece of qualifying equipment, you can deduct the FULL PURCHASE PRICE from your gross income. It’s an incentive created by the U.S. government to encourage businesses to buy equipment and invest in themselves.
The advantages shown above are not individually unique to an EFA but they are all available when using the Equipment Finance Agreement as your method of financing.
There is one big difference with an EFA that is unique and that is their flexibility. You can work with your financing partner to tailor the agreement to your business and what it needs to be profitable.
How Do I Get an EFA?
Equipment Finance Agreements are offered through independent financing companies. The company you look for should have experience with this type of financing and it is advisable to get counsel that can advise you on negotiating the contract.
It is important to know that you are protected under usury laws that prevent unacceptably high-interest rates and charges. It is still incumbent on you the borrower or lessee to make sure you understand what you are signing and how it will impact your business.
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