Equipment Financing vs Leasing for Small Businesses

A bakery owner I advised needed a $38,000 deck oven. The equipment dealer offered a lease at $890 a month for 48 months, and the owner nearly signed on the spot because the monthly figure fit her budget. When we added it up, the lease cost $42,720 before the end of term buyout. Her bank offered an equipment loan for the same oven at roughly $910 a month over 48 months, and at the end she would own it outright.

Equipment financing versus leasing is one of the most common funding decisions a small business makes, and it is usually made at a sales counter by comparing monthly payments. That is the wrong number to compare. The right choice depends on how long the asset stays useful, what happens at the end of the term, and how your cash and taxes look over the whole period. Here is how I run the comparison with clients.

Equipment Financing vs Leasing and How They Really Differ

With an equipment loan, you borrow money to buy the asset. You own it from day one, the equipment serves as collateral, and the lender can repossess it if you stop paying. Lenders commonly finance 80 to 100 percent of the price over two to seven years.

With an equipment lease, the leasing company owns the asset and you pay to use it. What happens at the end depends on the lease type, and that detail drives most of the real cost.

• Fair market value lease. Lower monthly payments. At the end you return the equipment, renew, or buy it at whatever it is worth then.
• One dollar buyout lease. Higher payments, and you buy the asset for a nominal $1 at the end. Economically this is close to a loan.
• Ten percent option lease. A middle ground where you can buy the asset for 10 percent of its original price at the end.

Compare Total Cost, Not the Monthly Payment

Build a simple table for every quote, using the full term and the end of term cost. Here is the bakery oven again, rounded.

The dealer lease looked cheapest each month and was the most expensive way to end up owning the oven. If you plan to keep equipment beyond the term, always price the buyout and add it to the total. Ask the leasing company to state the implied interest rate in writing. Many will not volunteer it, and when they do, it is often several points above a bank loan.

When Leasing Is the Better Choice

Leasing earns its place in specific situations, and it is worth being honest about them.

• Technology that ages fast. Laptops, point of sale terminals and diagnostic tools lose most of their value in three years. A fair market value lease lets you hand them back and upgrade.
• Very thin cash reserves. Many leases need only the first and last payment upfront, while a loan may need a 10 to 20 percent down payment.
• Uncertain demand. If you are testing a new service line, a short lease limits how much you are stuck with if the idea fails.
• Bundled maintenance. Some leases on copiers, vehicles or medical devices include servicing, which can be worth more than the rate difference.

Why the Tax Argument for Leasing Is Often Overstated

Salespeople love to say leases are better because payments are fully tax deductible. That is true for a true lease. It is also misleading, because owned equipment is deductible too, often faster.

In the United States, Section 179 and bonus depreciation can let a business deduct much or all of the purchase price of qualifying equipment in the year it is placed in service, even when it was bought with a loan. That can mean a larger deduction in year one than four years of lease payments would give you. Interest on the loan is deductible as well. Other countries have their own capital allowance rules that work in a similar direction.

The tax treatment can still favour leasing in years when profit is low and a big deduction would be wasted. The point is to run your own numbers with your accountant, not to accept the deduction pitch at face value. A one dollar buyout lease is usually treated as a purchase for tax purposes anyway.

What Lenders and Lessors Check Before Saying Yes

Approval is generally easier for equipment funding than for unsecured credit, because the asset backs the deal. Expect them to look at the following.

1. Time in business. Many banks want two years; many lessors accept six to twelve months.
2. Personal and business credit scores, with 650 or higher opening most bank programs.
3. Annual revenue, often a minimum around $100,000 for bank loans.
4. The equipment itself. Standard, resellable assets such as trucks or ovens get better terms than custom machinery.

If your business credit file is thin, building business credit from scratch before a large purchase can lower the rate by a meaningful margin.

Red Flags in Equipment Lease Contracts

Read the agreement before the delivery date, not after. A few clauses cause most of the disputes I see.

Hell or high water clauses

These require you to keep paying even if the equipment breaks or the vendor goes out of business. They are standard, but they mean the lessor is not responsible for quality. Check warranties separately.

Automatic renewal

Some fair market value leases renew for another 12 months unless you give written notice 90 to 120 days before the end. Put that date in your calendar the day you sign.

Vague buyout terms

If the contract says fair market value without defining who determines it, the lessor sets the price. Push for a fixed buyout figure or a defined percentage. More warning signs that apply to any financing are covered in telling good business funding from a trap.

FAQ

Can a new business get equipment financing?

Yes, though often through a lessor or online lender rather than a bank. Expect a higher rate, a larger down payment, or a personal guarantee in the first year.

Is it better to pay cash for equipment?

Only if paying cash still leaves at least two to three months of operating expenses in reserve. Draining cash for an asset that a cheap loan would cover is a common way profitable businesses end up short.

Does an equipment lease show up on my balance sheet?

Under current accounting standards for larger companies, most leases longer than 12 months appear as a liability. Many small businesses on simpler reporting may not show it, so ask your bookkeeper which rules apply.

The Practical Takeaway

Put every equipment financing and leasing quote into one table with the total paid, the end of term cost and ownership, then decide based on how long you will really use the asset. Finance what you will keep, lease what you will replace. Browse more options in the funding section.