Insights
Buying Equipment 101: What Small Business Owners Need to Know
By Vickie An
All businesses need the right assets and equipment in order to grow and succeed. Here are some tips on how to find and fund them.
What’s a restaurant without a range, an oven, a refrigerator or a freezer? Or a coffee shop without an espresso machine or a display case? How about a software company without computers and network servers? Practically any business you can think of requires the right equipment not only to operate, but also to grow and succeed.
But when it comes to purchasing fixed or tangible assets for your small business—defined by the U.S. Small Business Administration as things that go on your balance sheet, such as buildings, vehicles and equipment needed for regular business activity and that lose value over time—there are many things business owners should consider before moving forward with an acquisition, especially for big-ticket items. Here’s what experts suggest you do to ensure you’re making the right investments for your business.
Reevaluate your business plan
First things first: determine what assets and equipment are absolutely essential to running your business efficiently and effectively. Some important questions to ask: How will this asset add value to your business in the long term? Will it improve employee productivity and lead to increased profits? Do you need to upgrade your equipment to stay competitive in the market? Compile a list of assets you need versus assets you want, and include these in your business plan. Doing so will give you a clearer picture of how to budget for these purchases.
Once you’ve determine what you need, it’s time to start researching. It’s vital to do thorough comparison shopping to find equipment that will best serve your needs in the long run. And don’t be afraid to look for gently used products rather than buying everything brand new. Events like liquidation sales, estate sales and auctions can very well turn up gems.
Another lesser-known option to consider? Purchasing surplus goods from the government, which is affordable and easier than you think, said SBA economic development specialist Linda L. Williams in a recent webinar. These goods can comprise of anything from extra equipment, to foreclosed property, to assets that have been seized due to owners participating in illegal activities. The items are then either transferred over to another government agency or sold “as is” via public auction or negotiated sale.
“Here’s a situation where, if you do a really good job searching for what you need [on a federal auction site], and you can find it, you're probably going to get a very good deal,” Williams said. For example, she continues, “if you’re in lines of work that have to do with defense logistics, the military surplus site might be a good site for you.”
Here are a few others Williams recommends checking out:
U.S. Marshals Service - Seized Asset Information
U.S. Treasury - Seized Vehicles Sales
That said, while finding ways to save can help keep your cash flow in a positive position, it’s always best to go for quality over what’s simply the cheapest option with equipment investments.
Better to buy or lease?
Another key question for business owners is whether to buy the asset outright, or if it makes more sense to lease, said Williams. There are advantages and disadvantages to both. One benefit to leasing is that less cash or credit is required upfront. If you’re not ready to make a long-term commitment, short-term leases also allow you to take the equipment for a test spin. Sometimes maintenance may be covered by the package, too. And lease payments for business assets are typically tax deductible, although you should always work with a tax professional to be sure.
Every lease is structured differently, so if you do decide leasing is the best path for your business, make sure to examine the contract with a fine-tooth comb, or hire an attorney to assist.
Williams gave real estate as an example of one asset in which leasing the space might make more sense than buying the building. “Real estate is very, very expensive, and it’s also tied to certain geographic areas that your customers may be in, so you should really understand what your market is,” she said. Since small businesses, especially startups, are considered by lenders to be higher risk, business owners wanting to secure a loan to purchase property could be looking at high interest rates, she continued, so you may find that leasing is actually less expensive.
On the flip side, the lifetime cost of leasing can wind up being higher than if you buy, and replacing the equipment after your lease is up can also be pricey. Not only that, but typically, the depreciation of leased assets isn’t tax deductible—but again, always consult with a tax professional to help determine this, Williams counseled.
Every lease is structured differently, so if you do decide leasing is the best path for your business, make sure to examine the contract with a fine-tooth comb, or hire an attorney to assist.
“You may have heard the expression ‘the devil is in the details.’ Everything is in the details when it comes to a lease,” Williams said. She especially advised business owners to be aware of things like the lease type (for instance, operating leases work more like a rental, whereas capital leases work more like a loan), whether there is a buyout option, and any early termination penalties.
If buying—cash or credit?
Unlike leasing, if you determine that buying the asset is your best bet, you would be allowed to claim depreciation on your taxes and could cost you far less in the long run. Another benefit? You can include the asset on your balance sheet, too. However, buying does mean shelling out more cash or credit upfront and fewer opportunities to test drive the equipment, Williams said. In addition, if something malfunctions or breaks, the onus is on you to pay for maintenance or replacement.
Business owners who would prefer to save their working capital may turn to equipment financing, or the use of a loan, to purchase physical assets. There are a number of options available from lenders for equipment financing, including term loans, specialized equipment loans and business lines of credit.
When it comes to purchasing fixed or tangible assets for your small business, there are many things business owners should consider before moving forward with an acquisition, especially for big-ticket items.
Qualifying small businesses may also want to consider applying for an SBA 7(a) loan to cover equipment costs, which generally offer better terms and more generous borrowing caps compared to a conventional lender, says Wai-Chun Li, senior vice president and manager of SBA lending at East West Bank. For example, let’s say a business owner wants to buy a building. The SBA loan program requires only a 10 percent down payment versus the 35 to 40 percent usually required by a conventional lender. “So if the building costs $5 million and they apply for an SBA loan, they only have to pay $500,000 for the down payment,” Li says, doing the math. “If they go with a conventional lender, we’re talking about $2 million for the down payment at 40 percent.”
Another added benefit of securing an SBA loan for real estate is that the term is longer—25 years compared to five or ten years for a conventional lender, says Li. That means that every five or 10 years, the borrower would need to refinance the loan. But with an SBA loan, it’s “almost like a one-time deal,” he explains. “Ours is a full amortization term, and so they can just follow this payment schedule to pay off the loan in 25 years, without needing to refinance.”
This also eliminates having to pay various fees again, such as another loan fee, appraisal report fee, environmental report fee, etc. “An SBA loan eliminates all these renewal hassles for owners buying property,” says Li. You’d receive similar benefits—a longer term, translating into lower monthly payments—if you were using the loan toward equipment purchases or general working capital, too, he adds.
At the end of the day, if you do decide to fund the assets using cash, it’s imperative to make sure you have enough cash flow remaining to meet your immediate expenses.
“When most business owners start out, they totally underestimate their operating expenses, and they're not really ready to have cash available to meet their short-term expenses,” Williams explained. “If you can’t meet your obligations, it can have a monumental effect on your business. It may mean the difference of staying open or closing.”
After all, cash is king.