Running a small business often requires making savvy decisions about acquiring necessary equipment without overspending. One popular strategy among small business owners is equipment leasing, which allows you to use high-quality equipment without the financial burden of buying it outright. This guide will demystify equipment leasing, explaining why it's an attractive option for your business and providing insights to navigate the process effectively. What is equipment leasing? Equipment leasing is a long-term rental agreement. A piece of equipment is purchased by a lender and rented to a business for a specific period. In return, the business pays the lender a monthly fee for the duration of the rental agreement (aka lease) and can use the equipment as if it were their own. When the lease ends, the business has the option to renew the lease, purchase the equipment, or return the equipment to the lender. Lease payments usually remain consistent throughout the lease term. Terms While term lengths vary and will depend on your lender and unique situation, two-, five-, and 10-year terms are common. The amount available will depend on the cost of the equipment you are leasing, but can range from $5,000 to $5 million. Cancellation provisions. An equipment lease agreement will likely have a cancellation provision that addresses whether and when a lease agreement can be canceled and if there are any fees associated with a cancellation. Qualification criteria. Lenders will look at a combination of your credit score, annual revenue, time in business, and the value of the equipment you are leasing. In general, you will need a minimum credit score of 520 and an annual revenue of $50,000. While some equipment lenders do work with day-one startups, they will have higher minimum credit score requirements starting at 650. If you are leasing used equipment, the financier may also place restrictions on the age or mileage of the equipment. Equipment leasing vs. equipment financing. Your decision to lease equipment vs. finance equipment involves several considerations including the type of equipment you’re considering, how often you’ll use it, the cost of maintenance, the projected ROI, the resale value, and, of course, what you can afford (our equipment loan calculator can help with this). But these general rules will hold true across the board: Lease, if you’re considering a piece of equipment in danger of becoming obsolete. Finance, if the equipment is integral and a long-term part of your operation. Lease, if immediate cash flow is a concern, leasing may be more affordable. Finance, if investment, resale, and ROI are important to you. Equipment lease:Equipment loan:Monthly flat-fee rental costMonthly payment including a portion of the purchase price plus interestNo prepaymentPrepayments sometimes availableEquipment ownership varies by lease structureEquipment owned outright by the business. Is it cheaper to lease or buy equipment? The answer to this question depends on various factors, such as the cost of the equipment, the length of time it will be used, and the financial situation of your business. In general, leasing may be more affordable in the short term due to lower monthly payments, but buying can be more cost-effective in the long run, as you will own the equipment outright after making all payments. It's best to weigh the pros and cons of your specific situation before making a decision. Capital lease vs. operating lease. Think of a capital lease as something akin to ownership. When you enter into a capital lease, it's generally for the long haul, and the asset in question appears on your balance sheet. It's like taking out a loan to purchase the equipment outright, but you're making lease payments instead. This type of lease is usually for longer terms and by the end of it, you might even have the option to purchase the equipment for a nominal price. An operating lease is more like a rental arrangement. You're essentially renting the equipment over a shorter period, and it doesn't show up on your balance sheet. Operating leases are typically for less than the full useful life of the equipment, and once the lease term is up, the equipment is returned to the lender. This type of lease can be a good fit if you're after the latest tech and want to regularly upgrade your equipment. Types of equipment capital leases. The following are examples of how a capital lease would be structured. Equipment financing agreement - Fixed payments are made over a set term, after which you own the equipment in full. While similar to a loan, you pay a financing fee instead of interest. If you go this route, be prepared for slightly higher payments, but with no additional buyout cost at the end of the agreement. Note that tax benefits could help offset the cost of the monthly payments. $1 buyout lease - A $1 buyout lease is a lot like an equipment loan. You make payments to rent the equipment and purchase it for $1 at the end of the lease. 10% purchase upon termination (PUT) lease - With a 10% PUT lease, you purchase the equipment for 10% of its original cost when the lease ends. This structure allows for lower monthly payments with a predetermined cost for the final purchase. Types of equipment operating leases. The following are examples of how an equipment operating lease would be structured. Fair market value lease - With a fair market value lease, you make payments and use the equipment during the lease. At the end of the lease, you have the option to buy the equipment at fair market value, return it, or renew the lease. This type of lease is generally used for equipment that quickly loses its value such as computers or gym equipment. 10% option lease - The 10% option lease lets you make payments and purchase the equipment for 10% of its initial value or walk away once the lease comes to an end. Terminal rental adjustment clause (TRAC) lease - Typically used for semi-trucks and other vehicles, a TRAC lease comes with the option to purchase the commercial vehicle for the agreed-upon residual amount, or the lender will sell the vehicle to a third party. If the vehicle is sold for less than the residual amount, the lessee will owe the difference. Equipment leasing rates The cost of an equipment lease is determined primarily by the depreciation rate of the equipment, plus fees and taxes. The fee the company charges is called a money factor instead of an interest rate. It is multiplied by the financed amount plus the residual value of the equipment to create the monthly rent charge. That rent charge is then added to monthly depreciation to come up with your final lease payment. Depending on the structure of the lease, you will also either pay taxes up front, or they will be incorporated into your monthly payment. Equipment leasing formula. ((Finance Amount + Residual Value) * Money Factor)) + Monthly Depreciation + Taxes Monthly Lease Payment The money factor rate you pay to lease equipment for your business will depend on the leasing company or lender, as well as your business credit score, but rates can start as low as 6% to 8%. What is depreciation? Depreciation refers to the gradual loss of value of an asset, such as a piece of equipment, over time due to usage, wear and tear, obsolescence, or age. Additional costs Down payment - Many lease agreements offer 100% financing with no down payment. However, they may require your first and last monthly payment upfront. Documentation/processing fee - Some will require this fee, which is paid to the lender for processing your loan or lease application. Appraisal/site inspection fees - There may be a fee to appraise the equipment being purchased or to inspect a work site. Insurance - Equipment breakdown insurance is typically the responsibility of the lessee. You'll likely have to provide proof of insurance before you can take possession of the equipment. Maintenance costs - Depending on the structure of the lease, you may be responsible for any maintenance costs. Transportation/assembly costs - If the equipment needs to be transported to your place of business or assembled, you may have to cover that cost as well, which can be included in your total lease amount. Benefits of equipment leasing. There are numerous benefits that equipment leasing offers to small businesses, making it a compelling option for many. Let's delve into some of these advantages. Manages obsolescence. Some pieces of equipment risk becoming outdated. If you are considering using a piece of equipment that is in danger of being obsolete in the future, an equipment lease may be a better option than a loan. Cash flow benefits. Equipment leasing often has a lower impact on cash flow. Leasing spreads payments out over the duration of the lease, allowing your business’ cash to be used for other opportunities like paying expenses or funding your growth. Tax benefits. Lease payments are considered a tax-deductible expense. For a capital lease, businesses can also deduct the depreciation of the equipment. For operational leases, businesses can deduct depreciation if they purchase the equipment at the end of the lease. 100% financing. Unlike an equipment loan, which requires a down payment, many equipment leases offer 100% financing with no down payment. No debt on the balance sheet. If a company opts for an operational lease, it doesn’t appear on the debt or balance sheet, opening up more opportunities to secure other types of business financing at the same time. Steps to get an equipment lease. Getting an equipment lease involves a systematic process. Here are the suggested steps to follow: Identify your needs - Determine what type of equipment you need for your business. Whether it's machinery, vehicles, or office equipment, knowing what you need is the first step. Research leasing companies - There are numerous equipment leasing companies out there. Take your time to research and find the ones that cater to businesses like yours. Acquire quotes - Once you've identified suitable leasing companies, reach out to them for quotes. This will give you an idea of what the lease will cost you. Review the terms of the lease - Read the terms of the lease agreements you receive. Make sure you understand all the terms and conditions, including the lease duration, monthly payments, and what happens at the end of the lease period. Apply for the lease - After you've decided which leasing company and lease terms work best for you, fill out an application. You'll likely need to provide information about your business and financial situation. Approval and signing - If your application is approved, review the terms one last time, sign the lease agreement, and make any required down payment. Start using the equipment - Once everything is signed and sealed, the equipment is yours to use for the duration of the lease. Remember, always consult with a financial advisor or legal counsel before signing any lease agreements to ensure you're making the best decision for your business. In conclusion, equipment leasing and loans are powerful tools that can help you acquire the necessary equipment for your business' operation without breaking the bank. The right choice will largely depend on your business' unique needs and financial situation. At Lendio, we're here to make the process of acquiring business equipment as straightforward and cost-effective as possible. Visit our equipment financing page to learn more about how we can help your business grow.