Best practices in equipment financing
Many small businesses rely on equipment financing contracts and equipment leases to obtain office equipment or tools of the trade. Equipment financing and/or leasing helps businesses meet their equipment needs right away, but there are risks involved. Here are our top 5 tips for managing risk:
1. Don’t stop making payments under a lease or financing contract.
Equipment should always be inspected before the contract is signed. Most equipment leases and financing contracts contain, at the least, a clause indicating that the purchaser/lessee has had the opportunity to thoroughly inspect the equipment. Many contracts require the purchaser/lessee to indicate that they have inspected the equipment and that the equipment is in good working order. If the equipment malfunctions after that stage, it’s unlikely that the purchaser/lessee will be able to request repairs from the leasing company or equipment vendor. Almost all contracts allocate responsibility for repairs of business equipment to the business itself. Companies may be willing to negotiate warranty periods, but those need to negotiated up front and put in the contract.
2. Read the contract.
Don’t assume that the lease or financing contract is exactly like a business lease or financing agreement. Business contracts are generally form contracts that have been carefully tailored by lawyers. They’re almost always more beneficial to the vendor or third-party financing company. Business contracts can usually be negotiated, so if there are terms in the contract you don’t like, try to negotiate with the vendor. Or have your attorney negotiate terms.
3. The amount financed can change.
Equipment financing or leasing is like any other security agreement: the purchase or lease is secured by a loan, the vendor provides the equipment (and sometimes the lease or loan), the lender provides a loan. If you fail to repay the loan, the lender can repossess the equipment and sue the business for any deficiency balance on the loan.
The lender may reserve the right to adjust the amount financed—or your monthly payment level—to match the equipment cost and/or to cover any unexpected delivery costs. A huge adjustment is unlikely (for instance, the contract may cap the adjustment rate at 10%), but it’s good to be aware of this possibility. Additionally, make sure you’re aware of your interest rate. Payment increases may occur if you don’t have a fixed-rate loan or if your lease states that payments increase after certain amounts of time.
4. All your equipment might be collateral for a single loan.
Many businesses finance multiple pieces of equipment from the same lender. This allows lenders to do something called cross-collateralization: in addition to the specific piece of equipment for which a particular loan is granted, a lender may require that some or all of the equipment that your company owns be collateralized as a condition of issuing the loan. If you default, the lender can repossess all that equipment—not just the equipment which is the subject of the loan you default on.
Check whether there is a cross-collateralization clause in your contract. If there is, it’s a good idea to contact an attorney to provide guidance.
5. Nothing the equipment supplier does affects the financing contract.
A financing contract is typically a two-way agreement between you and the lender. If the equipment is supplied by a third party, your obligations to the lender aren’t affected by anything the third party does, unless the contract says otherwise. If the third party provides low-quality equipment that requires replacing, you still have to repay your financing loan to the lender on time.
Because the lender has the option to repossess the equipment if you default on your loan, it’s in your best interest to take care of that equipment. The financing contract will probably require that you keep the equipment insured and in good condition. It may require that you permit the lender to inspect the equipment. In addition, if the lender repossesses the equipment and its value has declined, you may be responsible for paying the difference.
As always, a good contract can help minimize your risk if an equipment financing arrangement goes sour. The attorneys at Zlimen & McGuiness, PLLC can assist you with contract drafting and review.