Every construction business owner gets to a point when a decision about new equipment must be made. There are many considerations, but one of the biggest is whether to lease or buy. Owners often wish for a cheat sheet to help them through the process.
Buy or Lease
Leasing heavy equipment is similar to leasing a car. Upfront payments to the lender are made in exchange for use of the equipment. When the lease period is fulfilled, the owner generally has the option to buy the equipment, turn in the equipment or extend the lease.
Buying heavy equipment is also like buying a car. The depreciation impact is immediate, and the owner is responsible for the equipment’s resale.
Leasing
Be sure to work with leasing or financing sources who have been in business for at least as long as your new lease would last, and be choosy when it comes to casualty insurance and terms. Your goal is to ensure that your purchase is covered in case of damage or repairs, or when needed to pay personal property tax.
Pros
- Frees up working capital
- Business expense deductions apply
- Can provide for equipment needs that may not be part of a long-term strategy
- Customized contractual end of terms available
- Immediate write-downs
- Choices for flexible payment terms
- Simplifies balance sheet management
- Often requires a lower down payment
Cons
- New companies may need personal funding for upfront costs
- Higher total cost
- Commitment to the equipment for lease term
Buying
When you commit to buying equipment, your business model should reflect how you will manage that equipment and address its resale. This helps to budget maintenance costs, depreciation and taxes, and to identify the best market in which to sell for profit.
Pros
- You own and control the equipment
- Purchase approvals may be swift, if you have a strong balance sheet
Cons
- Depletes working capital
- May put a strain on the business
- May require another large investment to upgrade the equipment
- If you have a less-than-stellar credit or the business has a lot of debt, purchase approvals may take longer or could be denied
Financing Options
Using all your business cash to buy heavy equipment is not the smartest business move. Remember, many types of heavy equipment qualify for financing. Using the cheat sheet, consider every option.
- Installment or secured business loan—The advantage to this option is that you own the equipment when paid off. However, it could make it difficult to have cash ready if more or newer equipment is needed while you’re paying the financing company.
- Operating lease—This is a rental agreement for a set period of time, with the option to return the equipment at the end of the lease term or extend with the option to buy.
- Capital lease—The lessee has an ownership interest in the equipment, and may report the lease as an asset and a corresponding liability.
- Fair-market value—This is a good option if you’re concerned about the ending value of the equipment. At the term end, you have three options—extend the term, return the equipment or buy the equipment at (then) fair market value.
- 10 percent security deposit—This option helps reduce monthly payments and decreases the overall loan amount. End-of-term options apply.
- 10 percent purchase option—At the end of term, you have the option to buy the equipment at ten percent of the original cost, continue to finance it or return it.
- $1 buy-out—This option applies when you know you want to buy the equipment upon term end. You may then buy it for $1.
Taxes
Equipment purchases can provide a much-needed boost to tax deductions, but the equipment must be in service before the end of the year to be claimed on your business taxes.
Effective Jan. 1, 2014, the maximum Section 179 deduction amount for property placed in service is $25,000. Experienced tax advisors can help ensure that all entitled deductions are taken properly.
In the end, whether you choose to buy or lease construction equipment, it should not tie up your company’s cash flow. It should work within your business plan and help to generate or even increase revenue while you have it.
The Ultimate Equipment Financing Cheat Sheet
Consider A Lease if You:
- Have little to no up-front capital available
- Do not require long-term use of equipment
- Will need to upgrade equipment every few years
- Seek immediate contracts with equipment use
- Need flexible payment options
- Require flexible contract terms
Consider Buying If You:
- Seek to own the equipment for potential resale in the near future
- Have sufficient business capital
- Have a long-standing relationship with financer
- Have a long-term business strategy that supports purchase
- Will not need equipment upgrades in the short-term
Finance Options
- Installment or secured business loan—Trade in current equipment or provide a low down payment with structured payments over time; allows for interest-expense deductions and depreciation
- Operating lease—Return equipment at end of lease term or extension with option to buy
- Capital lease—Lessee has an ownership interest in the equipment; may report lease as asset and corresponding liability
- Fair market value—Best represents the value of the equipment when financing is complete; small security deposit with low monthly payments
- 10 percent security deposit—If you can afford the down payment, it helps reduce monthly payments and decreases the overall loan amount; end-of-term option applies, including extending the agreement, or returning the equipment and requesting the security deposit
- 10 percent purchase option—Upfront amount is applied to the end of the term payment; at end of term, you have the option to buy the equipment at 10 percent of the original cost, continue to finance it or return it
- $1 buy-out—Options to buy the equipment upon term end; may buy it for $1
Final Steps
- Get another financing quote, even if you think you have a good one
- Ask for referrals for the equipment and the financing company
- Be picky when it comes to financing terms
- Understand the casualty insurance for damages and responsibility for personal property tax and repairs
- Learn more about the Section 179 Tax Deduction; some restrictions apply
- Speak with financial and leasing advisors that specialize in construction companies and heavy-equipment financing
