There are a lot of variables that go into structuring a term agreement for your equipment. Ensure that you get a financing plan that is structured appropriately for your business.
By Spencer Thomas
I am not breaking any news when I say waste management equipment and haulers are capital intensive. New or used vehicles can run upwards of $200,000 to $400,000, bins and software that are often overlooked can creep up and financially handcuff any company. Ensure that you get a financing plan that is structured appropriately for your business. There are a lot of financing options out there and tax savings available and, in the end, your bottom-line cost can vary by thousands of dollars.
Consider What Type of Financing Option is Right for the Company
By the time someone has determined they need a new vehicle, bins or software, found a vendor and settled on a price, the last thing they want to do is think about whether or not they are getting the best financing options, so they end up taking whatever terms their bank or the vendor’s financing partner offers.
There are a few things to consider when it comes time to financing your equipment. There are a lot of variables that go into structuring a term agreement—from market viability, the companies credit history, to the lenders understanding of the industry and the more prepared you are, the more likely you are going to get terms that will set you up for long-term success and stability.
Most people think they have three options when they are buying new equipment. They can either lease, finance or pay cash. While those are the three most commonly used, there are some other options that should be considered, depending on the situation.
Conventional Term Loan
This is a typical financing option generally offered from a traditional bank. Conventional Term Loans can be nice because they are very straight forward. You borrow a set amount and pay back the principal with interest over a predetermined number of months. When looking at a deal like this, review the prepayment penalty. Does it require an all business asset filing? Also, does it hold you to any financial covenants? Other drawbacks can be slow turnaround times and they generally require pledging all assets of the business and have high fees.
Equipment Finance Agreements (EFAs)
These are similar to the conventional loan but are specific to equipment and thus have some incentives for businesses. Similar to the conventional loan, you own the equipment. You then agree to pay the term of payments. The benefit over a lease is that by owning the equipment immediately it is listed as an asset on your balance sheet, and thus carries certain tax benefits. The drawback is they generally have higher payments because at the end of the term agreement the balance is $0, and you own it free and clear. A major reason to consider an EFA versus a conventional loan from a bank is that most banks will put a lien on all your assets whereas an EFA is not secured by present and future assets. Additionally, these have fast turnaround times, fixed rates and nominal fees.
At a very high level, a lease agreement essentially allows you to borrow the equipment for the length of the deal and then at the end of the term agreement, you can decide whether to extend the lease (and keep using the equipment), purchase the equipment for whatever balance is remaining, or return it and possibly invest in an upgraded model and begin a new lease agreement. The benefits of leasing are that you keep your monthly payments lower, you can continually upgrade to the latest industry innovations, and you also have the opportunity to purchase the equipment by paying off the remaining balance.
The first step in considering a lease is whether you need a Capital Lease or an Operating Lease. The fundamental difference between the two is that a Capital Lease is treated more like a loan, and thus you are considered the owner throughout the life of the term agreement and would have it listed on the balance sheet. Whereas an Operating Lease is treated more like “renting” so the lessor is considered the owner and thus the equipment would stay off the balance sheet. Beyond assets versus expenses on the balance sheet, each lease has different tax implications, primarily that a Capital Lease allows the owner (you) to claim depreciation expense and interest expenses. Conversely, with an Operating Lease, the lessee (you) is renting the equipment, thus the payments are considered to be rental expenses. (There are more tax considerations that we will discuss later in the article.)
This is a type of hybrid debt product that can be very useful for companies with lower credit scores. In these scenarios, the lessee (you) would sell the equipment to the lessor (financial institution) and then the lessor would immediately turn around and lease it back to the lessee (you). This is a great way to free up cash for other investments, keep your equipment and get the lease benefits.
SBA 7(a) Loans
These loans are done through a bank and are partially guaranteed by the government. They have a set of criteria that you need to meet to qualify. This is set by the SBA (Small Business Administration) in addition to the bank approving your deal. This can be an attractive option if the financing package makes business sense. They typically have the same terms as a conventional term loan with all business asset filing and financial covenants, which is something to take into consideration from a long-term business planning standpoint. Regardless of the financing option you choose, the biggest benefit is that you will be able to use your equipment and earn revenue from it while you are paying it back, so, in theory, the equipment is paying for itself (or some portion of it) and you did not have to deplete your cash reserves, which now can be invested somewhere else. If you are not sure which option is best suited for you, talk to a financing company and they can run an analysis and guide you in the right direction.
Things to Keep in Mind
Get Multiple Quotes
Do not just accept your first quote. If you go to a traditional bank or single source financing partner, your payment amount and structure will vary significantly depending on the lender’s risk portfolio and their current diversification needs. If you are considered a high-risk client, you will be paying for it in higher monthly payments and down payments.
Consider talking to a company that specializes in equipment financing. Some equipment finance and leasing lenders have experience in the waste management industry and are comfortable with the strengths and risks of your business. Another benefit to using a company that solely focuses on equipment financing is that they can move much quicker than a traditional bank and get the vendor a check in as little as 24 hours.
Consider the Tax Implications
Tax savings via Section 179 and bonus depreciation tax laws allows companies to deduct 100 percent of the purchase price of qualifying equipment or software that was financed or purchased during the tax year. This is true cash savings. If you have someone managing your taxes, I highly recommend talking to them to consider all of the tax benefits that can be factored into your purchase.
Talk to Your Lender About the Specifics of Your Business
Help your lender understand what challenges your business is facing and how you intend to use your equipment. A benefit of working with an established equipment financing company is that they will often times have someone there who is very familiar with the waste management industry and can help you identify obstacles and opportunities that you may not have seen. On top of that they can be extremely flexible with repayment options and structure payments according to your cashflow to alleviate any potential hardships of having to make a payment in a downturn month leaving you with no reserves. A few common repayment options are:
1. Straight Payments: These are calculated by taking the amount being financed plus interest and dividing evenly by the number of term payments. The amount due will be the same every month.
2. Seasonal or Skip Payments: This gives you the opportunity to choose the months you want to make payments and in turn have months where only a small touch payment is owed. This payment plan makes sense if the equipment is only used seasonally.
3. Step Payments: These are designed to have very small payments in the beginning of the deal, typically three to four months, and progressively get larger. This design allows you to time the revenues the equipment generates with the payment obligation.
Walking Through the Process
As you can see, there are many options to be considered and while there are no wrong choices, there will be one or two options that will be right for your business. I highly recommend talking with a company or bank that is experienced in equipment financing. They can help you through the process and have your best interests in mind when negotiating the terms. If you do not know of any companies off hand, a simple google search will provide you with a broad list of companies to reach out to. | WA
Spencer Thomas, CLFP, is the President of KLC Financial based in Minneapolis, MN. Spencer has nearly two decades of experience in the equipment leasing and financing industry. He has a proven track record of success in working with hundreds of financial institutions and small businesses, structuring transactions and funding more than $1B. Spencer can be reached at (952) 224-4303 or e-mail Spencer@KLCFinancial.com.