There are a number of lenders that provide loans for business assets, and they do this in a variety of different ways. However, there are some restrictions on the types of assets (equipment or machinery) that they will finance.
What they don’t finance
- Machinery less than R50 000: It’s just not profitable for them to be dealing with small loans. It can be easier to finance less costly equipment through overdrafts, credit cards or term loans.
- Second-hand machinery: The lenders are loaning you money to buy equipment or machinery. If you don’t pay back the loan, they need to make sure the asset has a high resale value. This is unlikely to happen with second-hand machinery. However, there are some types of equipment or machinery that still have a good resale value even if they are second-hand e.g. cars. So it is up to you to prove to them that the equipment or machinery will have a high resale value.
- Very specialised machinery: The more specialised and specific an asset is, the harder it is to resell. Also, there might not be a market for the specialised machinery, and this makes formal lenders nervous.
How asset finance works
There are three basic ways formal asset financiers structure their loans:
- Instalment sales agreement.
- Lease agreement.
- Rental agreement.
Option 1: instalment sales agreement
With this option, the business buys the asset with a prime-linked loan from the lender. You then pay this back in equal instalments, over a 60-month period (plus interest of course). Sometimes the period can vary from 12 months to 10 years – this depends on the life of the asset.
While you’re paying off the loan, the lender owns the asset, in the event that you can’t pay back the loan and they need to sell the asset to recover their money.
You can’t sell the asset without the lender’s consent. Once you’ve paid back the loan to the lender, the ownership of the asset reverts back to you.
Option 2: lease agreement
Here are the basics for this option:
- The lender still has ownership of the asset while you are paying it off.
- The business gets to use the asset for the period of the finance, usually 60 months.
- At the end of the lease period, you have the choice of buying the asset from the bank for a residual amount or giving the asset back to the bank.
Option 3: rental agreement
This is also known as an “operating lease” and is similar to a lease agreement. However, once the contract comes to an end, the business won’t have the choice to buy the asset. The asset is returned to the lender, who can rent it to someone else.
With rental agreements, the monthly payment is usually slightly lower than that of a lease agreement, or an instalment sale. A rental agreement can include a full maintenance service, which means the lender is responsible for the repairs and maintenance of the asset. In this case, the monthly payments will be higher.
As you gathered from reading this module, a lease agreement appears a lot like an instalment sale agreement in disguise, with the exception that you do not have to purchase the asset at the end of the lease. A rental agreement isn’t as similar, because it never will be your asset – someone else (the lender) owns the asset and you are merely renting it. Also, the full cost of the rental is deductible as a business expense and therefore there can be tax benefits.
If you are short on cash-flow, a rental agreement may be tempting because the monthly payment is usually slightly lower than the other two options. The only catch is that this may be a great option in the short-term, but can become costly in the medium to long-term. You continue to make payments, but you are not building up to eventually owning the asset.
The type of agreement you go for also depends on:
- The type of asset you want to buy.
- Whether you want to own, or just have access to, the asset to use.
For example, with a computer, technology changes so rapidly that it can become worthless quite quickly. So perhaps in this instance, consider a rental agreement. An industrial tool such as a combine harvester has a longer lifespan of 40 to 50 years, so in this case, it makes more sense to buy one.
Some other options
There are different ways to finance the purchase of equipment or machinery other than asset finance options. These are discussed in the module Do you need finance for equipment and machinery?