Small Business

How To Plan A Loan To Buy Equipment For Your Business

Business owners can enhance the bottom line of their enterprise through boosting profit, cutting costs, or both. An investment in new equipment is one of the ways to accomplish both.

Nearly every business can benefit from equipment upgrades. New machinery builds efficiencies and allows owners to manage growing customer demand. The Equipment Leasing & Finance Foundation predict a robust commitment to upgrades in the months ahead, forecasting that "equipment and software investment should expand by about 3.0%."

Reasons for companies to invest sooner rather than later include the anticipation of further interest-rate hikes by the Federal Reserve that could drive up the cost of business loans and other credit before the end of 2017.

That said, firms considering new equipment need to strategize their financing. In many cases, a loan is the best option because it allows companies to preserve capital for cash flow needs, and to enjoy the economic benefit of new equipment without the need to amass the necessary funding first. Here are some tips on planning and selecting the right loan.

Develop an expectation of useful life

In other words, consider how long you will be using the equipment. This question is important because it’s wise to choose a loan with a term identical to the life of the equipment. This approach avoids the trap of burdensome payments long after the equipment has served its purpose or high payments before realizing the value of the purchase.

Decide on the type of lender

The next decision will be critical: You can finance with an ordinary bank or an online lender. Cost should be the driver of this choice. A traditional bank, in most cases, will offer more favorable interest rates. Conventional brick-and-mortar banks still have cheaper access to cash despite the recent rise of online lenders. Ordinary banks can borrow from the Federal Reserve at aggressively low rates. Meanwhile, cash from online lenders often comes at a higher cost although the approval process is faster and more accommodating.

Despite a higher cost of capital, an online loan may be necessary for a small business. The reason: There has been a continued downtrend in lending from banks to small businesses. "Together, 10 of the largest banks issuing small loans to business lent $44.7 billion in 2014, down 38% from a peak of $72.5 billion in 2006," reports The Wall Street Journal. Meanwhile, nonbank lenders have seized the opportunity and captured 26% market share up from 10%.

Banks sometimes downplay small-business loans because they lack a standardized approach that streamlines conventional lending for mortgages and credit cards. Each small business loan request is different, which can make credit decision process less conventional, more time-consuming, and therefore possibly less profitable.

For these reasons, it can make sense to tap loans that are associated with the federal Small Business Loans program. The SBA doesn't lend directly to the borrower. Rather, they are an intermediary connecting the bank to the business seeking funds. This relationship solves the problem discussed above because the SBA handles the application process and guarantees the loan. This can give both offer the bank an assurance of repayment and are unencumbered with credit evaluations and paperwork.

Know The Market

Interest rates will vary across lenders, with banks typically offering lower interest rates than alternative or online lenders. Loans backed by the Small Business Administration also offer competitive rates, even when compared to bank loans.

Banks spend the same amount of money and time underwriting small and large loans, and since big businesses tend to borrow larger amounts, banks will earn more from them. As a result, banks typically charge small businesses more to make the investment worthwhile for them. As a general rule of thumb, the smaller the loan amount or the shorter the length of the loan term, the higher the interest rate from a bank will be. Another factor that can affect your interest rate is your relationship with the lender. Some lenders will offer lower interest rates or reduced fees for borrowers that have taken out multiple loans and repaid them on-time. This is true for both banks and alternative lenders, so it may be a smart idea to do your borrowing from one place.

Justin Song

Justin is a Sr. Research Analyst at ValuePenguin, focusing on small business lending. He was a corporate strategy associate at IBM.