Updated: Dec 9, 2019
Cutting-edge tools and equipment are a huge competitive advantage for a construction business. But, with all the equipment and heavy machinery needs, it is usually impossible to pay for everything in full using your own capital. Especially in an industry where there is a long period between billing and collection, a huge cash outflow all at once may not be a good business decision. That’s where the choice between equipment leasing vs equipment financing comes in.
When deciding between leasing and financing construction equipment, you need to consider several factors—the size of your business, the pieces of equipment needed, the cost of maintenance and repair, and the resale value.
To help you with your decision, here are the risks and benefits of equipment leasing vs equipment financing.
Being able to negotiate the lease term and payment structure that works for your business is one of the biggest advantages of equipment leasing. At the end of the lease term, you may be able to renew the lease, purchase the equipment at present value, or even trade the equipment for a newer version. This enables you to maintain your competitive advantage by staying up-to-date with the current technology without worrying about being stuck with obsolete equipment.
With equipment leasing, you do not have ownership of the leased equipment. This means you are responsible for it only during the time you use it. It is the lessor who has the responsibility to provide maintenance and dispose of it once it has become outdated.
As leasing a piece of equipment spreads your payments over a period, it has a low impact on your cash flow. Leasing also does not require a down payment or collateral. Because of this, you are free to use your cash for payroll, expenses, and funding your projects.
Compared to an equipment loan, equipment leasing has a higher total cost. There is no interest on your monthly payments, but the lessor still puts an effective interest rate to gain profit, with rates that can go as high as 30%.
If you opt to go the lease route, then be prepared to deal with limited equipment availability. Your choice of brand or model may not be available, so you may need to settle for a different one from what you originally wanted.
An equipment loan is easier to qualify for even if your credit history is not that stellar. Because the equipment loan is secured by the piece of equipment itself, the lender will not ask you to offer additional collateral.
Compared to an equipment lease, the total cost you will pay in full will be lower if you choose equipment financing. The loan is structured in a way that you pay for the interest in addition to the principal amount of the loan, but the interest rate is usually lower compared to the effective interest rate of a lease. Rates for equipment financing range from 2% up to 25% depending on your credit score, but the average is usually in the single digits. In contrast, effective interest rates for equipment leases average in the teens and can go as high as 30%.
Another big advantage of equipment financing is the tax benefits they give businesses. According to Section 179 of the IRS tax code, the maximum annual tax deduction that business owners are entitled to go up to $500,000.
Unlike an equipment lease, equipment financing usually requires an initial down payment. There are cases where a lender may loan 100% of the cost of the equipment, but usually, lenders only give around 80%. You need to pay for the remainder upfront. This can be an issue if you have cash flow problems.
Full ownership of a piece of equipment means you shoulder the risk of using it even if it has become obsolete. Before applying for a loan, make sure that the equipment will not be outdated quickly. Using outdated technology may compromise jobsite efficiency and could also come with safety risks. When the equipment does become obsolete, you will likely be forced to make another high-ticket purchase while significant capital sleeps in the form of obsolete equipment.
Depending on your own business situation, some of these benefits may outweigh the risks. Evaluate the state of your finances, your business needs, and the piece of equipment that you want to acquire to make a sound decision.
Patrick Hogan is the CEO of Handle.com, where they build software that helps contractors, subcontractors, and material suppliers secure their lien rights and get paid faster by automating the collection process for unpaid construction invoices.