Equipment finance overviewEquipment finance is used to purchase a specific piece of equipment. The different types of equipment finance (also known as asset finance) change how you use and come to own that piece of equipment. Indeed, under some of these arrangements the lender providing the finance actually has ownership over the equipment, and you are just ‘hiring’ or ‘leasing’ it from them for business purposes (even though you will select, purchase, pick-up, house and run the equipment!).
Deciding between these options requires a careful consideration of cash available to contribute to the equipment as well as important financial consequences like having access to the depreciation expense on the asset, and re-couping GST (if applicable).
What is a hire-purchase agreement?
This form of equipment finance is where a contract is drawn up to purchase a piece of equipment over time from a lender. Technically you don’t own the equipment while making the payments but you are entitled to use it during this ‘hire’ period. Then, when the last payment is made, ownership of the piece of equipment is transferred to you. Hire-purchase agreements can be structured flexibly to include deposits upfront (to bring down future repayments), ‘balloons’ at the end (lowering repayments but requiring a larger lump sum payment at the end), and the ability to return the asset to the lender during the ‘hire’ period if it is no longer required.
Benefits of a hire-purchase agreement
As noted above, flexibility of repayments, upfronts, and balloons is a big benefit of hire-purchase agreements. Repayments are tax deductible expenses, and you can claim depreciation on the equipment (even though you don’t technically own it). This means that hire-purchase will often confer more tax benefits than just leasing the equipment, particularly in the early years of the agreement.
There can also be benefits in terms of financial reporting. During the hire period, the equipment is not owned by the business, so neither the equipment (asset) nor finance (liability) will be on your balance sheet. Instead, the repayments appear on the profit & loss statement as an expense. This can make business performance metrics look superior to owning the asset outright, depending on the business.
Drawbacks of a hire-purchase agreement
Equipment loan / chattel mortgage
What is an equipment loan / chattel mortgage?
Think of this as a regular loan, where the lender gives you cash to buy an asset and then takes that asset as security for if you fail to repay the loan (just like your home mortgage!). This is how an equipment loan or chattel mortgage works. The lender will give you the cash to purchase the equipment then use the equipment as security for the money you are borrowing from them.
Benefts of an equipment loan / chattel mortgage?
Equipment loans and chattel mortgages are popular methods of financing new pieces of equipment. This is because, first and foremost, you own the piece of equipment are not subject to any restrictions on how to use it (as in a hire purchase agreement). The equipment is also the only security that is required for the loan, making it a lot easier to free up other potential security.
Chattel mortgages / equipment loans also get favourable GST treatment – as you are making the full purchase upfront you can claim back any GST input credit in full at the time of purchase – this becomes especially valuable on larger purchases.
Drawbacks of an equipment loan / chattel mortgage?
Equipment loans often have higher credit quality requirements and can require more contribution upfront. Equipment loans also tend to have higher fees compared to hire-purchase or leases, as setting up the equipment loan costs the lender more time and documentation compared to the other types of equipment financing.
It also bears noting that, since you own the asset, there is no option to return it to the lender! Further, the equipment will sit on your balance sheet as an asset (with the chattel mortgage on your balance sheet as a liability).
What is a lease agreement?
A lease is similar to a hire-purchase agreement in that you do not own the piece of equipment you are using. Instead, you are ‘leasing’ it from the lender by paying a regular ‘rental’ fee (similar to renting an apartment). However unlike a hire-purchase agreement, you may not automatically own it at the end of the repayment period. Depending on the terms of the agreement with the lender you may have the option of purchasing the equipment at its depreciated value, extending the lease period, or returning the equipment.
Further, depending on the type of lease, the leasing company may stay responsible for maintenance, registration and insurance costs (meaning these costs end up being included in the rental payment in order for the finance company to make their profit!). In comparing leases with other finance options, it is important to know who ends up paying for these costs so that you can compare apples to apples.
Benefits of a lease agreement
Using a lease to get new equipment is often fast and easy, as the vendor of the equipment may offer the lease agreement themselves as part of the sale process. Leases are often preferred when you don’t actually want to own the equipment forever, and would like to upgrade after a known period of time (e.g., with computer equipment that becomes obsolete quickly).
Lease payments are tax deductible just like interest on a business loan. Additionally, you do not pay the GST on the asset - the lender owns the asset fully so they handle the GST whilst you only pay for the ex-GST cost.
If your lease is an operating lease, then the lessor may be responsible for maintenance and repairs on the equipment. Finally as you are leasing the asset you don’t have the equipment on your balance sheet – either an asset or a liability.
Drawbacks of a lease agreement
Whilst leasing offers many benefits, it also has some drawbacks. These include not being to include depreciation expense on the equipment to lower your tax bill.
Further, a leasing arrangement will have terms and conditions on allowed uses of the asset in order to preserve its value for the lender. You may have to work these use restrictions into your operating processes or at least be aware of them if an extraordinary use-case for the equipment comes up.
If you have a purchase option under a finance lease but don’t purchase the equipment and the lender needs to sell it on the market, you may be liable if the sale price is less than the depreciated value of the equipment, so look out for this in the terms and conditions.
Early termination of the lease can also incur fees from the lender, which is worth keeping in mind your business needs are likely to change.