The basics of equipment financing

As we continue to enjoy the prolonged economic recovery, fabrication businesses continue to grow. With older equipment being replaced and new equipment purchased for expansions, shop owners have an ever-growing spectrum of financing options available to them.

In the last few years many regional banks have opened equipment finance divisions, and new specialty finance companies have emerged. Even machine tool vendors increasingly are offering financing options. It is a buyer’s market for fabricating businesses as all of these entities compete for equipment financing business.

Additionally, thanks to advances in technology, you need to wait only a few days to learn whether or not you are approved for financing. The time frame can take longer, depending on size and complexity of the transaction, but in most instances news about financing is quickly received.

The Financing Sources

To ensure that you find a lender that is the best fit for your needs, you must have a thorough understanding of available financing options. Generally, the providers of financing can be placed in three categories: banks, vendors, and specialty finance companies. Each has its own advantages and disadvantages.

Banks have always provided equipment financing to their large clients, and recently many banks have started offering equipment financing to smaller businesses that may not be existing clients of the bank. The primary benefit of bank financing is that it is likely to be the cheapest. Banks have a low cost of capital and are able to pass this on by offering low-interest loans to those who qualify. Another advantage is that banks frequently offer financing with small prepayment penalties, allowing you to pay off the loan early.

Banks tend to be conservative and lend only to strong businesses with a history of positive performance and outlook. To qualify for a loan, a fabrication business may have to provide a robust financial package that includes audited or reviewed financials. Banks tend to mirror one another in their underwriting practices, and because of that, negative one-off events, such as the loss of a big customer, or recent business issues, such as turnover in key areas, may disqualify a business from this source of lending. Usually the business needs to contribute equity into the financing, with the bank funding the balance, and personal guarantees may be required.

Many equipment vendors now offer financing either directly or through lending partners. This can be a convenient solution as the equipment and financing come from the same source. Eliminating the need to look for financing elsewhere can free up significant management time. Also, as vendors strive to build brand loyalty and develop long-term relationships, the financing may come with options, such as allowing the shop to upgrade or exchange the equipment as new models or upgrades are developed. For businesses committed to staying current with the latest fabricating technology, this can be a particularly attractive option. Obtaining financing at the point of sale also may result in a longer or cheaper warranty.

The convenience of the one-stop lending arrangement may come with a cost that is typically more expensive than bank financing. Further, because vendors are focused on selling equipment and not providing financing, they tend to be selective and lend to stronger credits.

In recent years dozens of new specialty finance companies (SFCs) have formed, providing equipment financing to every business sector. Their primary focus is lending to businesses that are not able to reach terms with banks or their vendors. Potential customers for these SFCs include newer businesses, those that experienced prior revenue losses, or those that face an uncertain future. SFCs also may be able to finance some of the soft costs, such as shipping and installation.

SFCs are known to demonstrate some flexibility with their clients, such as offering an interest-only period or a seasonal repayment schedule. Of course, as the SFCs are willing to take on more risk, they charge higher prices, and they tend to be the most expensive of the three options. The financing often comes with stiff prepayment penalties as the SFCs want to ensure they are not easily refinanced with a cheaper option as your business improves.

Working With These Financing Firms

To maximize your available options and obtain the most suitable financing, you need to deliver all the information lenders require in a timely fashion. All funding sources are likely to ask you for your historical financial information, financial projections, and a detailed list of planned equipment expenditures.

Banks and vendors have a preference for audited or reviewed financials and tax returns. SFCs also look closely at your business plan, overall company strength, and the management team’s commitment.

More information means the lender can understand your business more fully. This often leads to a faster approval or a quick “no,” which allows a business to focus on other options. For more guidelines on working with financing firms, see the infographic The Dos and Don’ts of Equipment Financing.

Finding the right financing partner can play a key role in the future success of your business. This should not be a rushed process. As the lenders are doing their due diligence on you, you should perform due diligence on them.

Look for funders who want to meet face to face. Someone willing to spend a lot of time learning about your business likely will be an easier partner to work with if unforeseen business challenges arise. As you’re going through the process, confirm the person you are working with on the transaction will be your point of contact for the life of the financing. Often promises are made upfront that may not be honored once the ink dries, and the agreement has been moved to another relationship manager.

Ask the lender for referrals of similar companies they financed. Speaking to other business owners about their experiences can be a great tool in the selection process.

Fabrication shops that are new to financing can start with an alternative lender while they improve performance and reporting, then refinance using a less expensive bank loan. Of course, be aware of any prepayment penalties when evaluating your options. It is best practice to obtain several term sheets and proposals before making a decision.

Avoid the tendency to focus on the interest rate, and be sure to understand all other fees and expenses associated with the financing. You should be cautious of deals that are too good to be true, as you may become a victim of a bait-and-switch. As with any contract, read the fine print prior to signing.

The current state of the economy is the perfect time for fabricators to obtain attractive equipment financing terms. Diligent businesses that select the right financing partner in today’s environment will form relationships that will take them through any economic downturns that may come.

Mike Miroshnikov is president, Arboretum Commercial Finance LLC, 603-294-1420, www.arboretumcf.com.