When your business needs new equipment, two primary options exist: financing (purchasing with a loan) or leasing. Both approaches have distinct advantages and disadvantages that can significantly impact your business's financial health and operational capabilities. This guide will help you understand the key differences between equipment financing and leasing to make the best decision for your specific situation.
Equipment Financing: An Overview
Equipment financing involves borrowing money to purchase equipment outright, then repaying the loan with interest over time. At the end of the loan term, you own the equipment free and clear.
How Equipment Financing Works
- You select the equipment you need
- A lender provides funds to purchase the equipment
- The equipment serves as collateral for the loan
- You make regular payments (typically monthly) for a set term
- Once the loan is repaid, you own the equipment outright
Pros of Equipment Financing
- Ownership: You build equity with each payment and eventually own the asset
- Tax Benefits: Potential for Section 179 deduction, allowing you to deduct the full purchase price in the first year (up to $1,080,000 in 2022)
- No Usage Restrictions: Freedom to modify or use the equipment as needed without lease limitations
- Fixed Payments: Predictable payment schedule with no end-of-term surprises
- Build Business Credit: Timely loan payments help establish and improve your business credit profile
Cons of Equipment Financing
- Higher Initial Costs: Typically requires a down payment (10-20% of purchase price)
- Maintenance Responsibility: You're responsible for all repairs and maintenance
- Obsolescence Risk: You own the equipment even if it becomes outdated
- Balance Sheet Impact: The equipment and loan appear on your balance sheet, potentially affecting your debt-to-equity ratio
- Longer Approval Process: May require more extensive documentation than leasing
Equipment Leasing: An Overview
Equipment leasing is essentially a rental arrangement where you make regular payments for the use of equipment without actually owning it. At the end of the lease term, you typically have options to purchase the equipment, renew the lease, or return the equipment.
How Equipment Leasing Works
- You select the equipment you need
- A leasing company purchases the equipment
- You sign a lease agreement to use the equipment for a specified term
- You make regular lease payments for the duration of the agreement
- At the end of the term, you choose from end-of-lease options (return, purchase, or renew)
Types of Equipment Leases
Operating Lease (Fair Market Value Lease)
This type of lease typically has lower monthly payments because you're only paying for the use of the equipment during the lease term, not the full value. At the end of the lease, you can purchase the equipment at its fair market value, renew the lease, or return the equipment.
Capital Lease (Finance Lease or $1 Buyout Lease)
With this lease type, payments are higher because they cover most of the equipment's cost over the lease term. At the end of the lease, you can purchase the equipment for a nominal amount (often $1). This type of lease is more similar to financing in structure.
Pros of Equipment Leasing
- Lower Initial Costs: Little to no down payment required, preserving working capital
- Maintenance Coverage: Many leases include maintenance and repair services
- Flexibility to Upgrade: Easier to upgrade to newer technology at the end of the lease term
- Tax Deductible Payments: Operating lease payments can typically be deducted as business expenses
- Off-Balance Sheet Financing: Operating leases may not appear as debt on your balance sheet
- Simpler Qualification: Often easier to qualify for than equipment loans
Cons of Equipment Leasing
- Higher Long-Term Cost: You'll typically pay more over time compared to purchasing
- No Ownership Equity: Payments don't build equity unless you exercise a purchase option
- Usage Restrictions: Lease agreements may limit how you can use or modify the equipment
- Contractual Obligation: Difficult and potentially costly to terminate a lease early
- End-of-Term Decisions: Must decide whether to buy, renew, or return at the end of the lease
Side-by-Side Comparison
| Factor | Equipment Financing | Equipment Leasing |
|---|---|---|
| Ownership | You own the equipment after loan repayment | Leasing company owns unless you exercise purchase option |
| Upfront Costs | Down payment typically required (10-20%) | Little to no down payment |
| Monthly Payments | Generally higher than operating leases | Generally lower, especially for operating leases |
| Tax Benefits | Section 179 deduction, depreciation, interest deduction | Lease payments may be fully deductible as business expenses |
| Maintenance | Your responsibility | Often included in lease agreement |
| Obsolescence Risk | You bear the risk | Leasing company bears the risk (for operating leases) |
| Term Length | Typically 2-7 years | Typically 2-5 years |
| End of Term | You own the equipment outright | Purchase, renew lease, or return equipment |
When to Choose Equipment Financing
Equipment financing is generally the better option when:
- You plan to use the equipment for the long term (longer than the financing term)
- The equipment has a long useful life and won't quickly become obsolete
- You want to build equity and eventually own the asset
- You want to take advantage of Section 179 tax deductions
- You need to customize or modify the equipment for your specific needs
- The equipment will retain its value over time
When to Choose Equipment Leasing
Equipment leasing is generally the better option when:
- You need equipment that requires frequent technology updates
- You want to conserve working capital with minimal upfront costs
- You need equipment for a specific project or limited time period
- You want to include maintenance and service in your payment structure
- You want the flexibility to upgrade at the end of the term
- You want to keep the equipment off your balance sheet (operating lease)
Tax Considerations
Tax treatment is an important factor in the financing vs. leasing decision:
Equipment Financing Tax Benefits
- Section 179 Deduction: Deduct the full purchase price of qualifying equipment in the first year (up to $1,080,000 in 2022)
- Bonus Depreciation: 100% first-year bonus depreciation for qualified new and used equipment
- Interest Deductions: Interest paid on equipment loans is tax-deductible
- Regular Depreciation: Depreciate the cost of the equipment over its useful life
Equipment Leasing Tax Benefits
- Operating Lease: Lease payments are typically fully deductible as business expenses
- Capital Lease: May qualify for Section 179 deduction and depreciation similar to financed equipment
Always consult with a tax professional to understand the specific tax implications for your business situation.
Working with Nexli Funding
At Nexli Funding, we offer both equipment financing and leasing options tailored to your specific business needs. Our equipment funding specialists can help you:
- Analyze your equipment needs and financial situation
- Compare financing and leasing options with detailed cost projections
- Structure the most advantageous terms for your business
- Expedite the application and approval process
- Provide ongoing support throughout the term of your agreement
Conclusion
The choice between equipment financing and leasing isn't one-size-fits-all. The right decision depends on your specific business circumstances, including cash flow, tax situation, equipment type, and long-term plans.
By carefully weighing the pros and cons of each option and considering the factors outlined in this guide, you can make an informed decision that supports your business's operational needs and financial health. Remember that you can also use a hybrid approach, financing some equipment while leasing others based on their specific characteristics and your usage plans.
