One of the more significant decisions for a new or growing aesthetic business venture is whether or not to finance the purchase of their medical equipment. Whether driven by limited financial resources or the desire to maximize return on invested capital, it is a very important part of the business planning process.
Sources of Equipment Financing:
Whereas it is a less common source, certain individuals or entities may find their local bank or financial institution able to offer financing. Often times this can be available as a result of a long standing or broader relationship. If you are able to secure financing from these sources, the distributor or manufacturer will be able to provide the purchase agreement and invoice that the bank will need to fund the purchase.
The more common source of funding for aesthetic equipment financing is a specialty equipment finance company. The guidelines that follow are specific to these institutions.
Types of Equipment Financing:
Broadly speaking, financing is available as either a lease or a loan, depending on the client’s credit profile and finance objectives. The primary difference is when ownership transfers to the client. With leases, ownership transfers at the end of the period and upon successful completion of the lease terms. With loans, ownership transfers upon payment to the distributor at the beginning of the financing term.
Types of Leases:
Leases can be classified as either Operating Leases or Capital Leases. Generally speaking, most equipment financing leases are Capital Leases. The accounting treatment for the two types of leases are the primary difference.
With both Equipment Finance Agreements (EFAs) and Capital Leases, the tax advantages include the ability to deduct interest (or implied interest), as well as depreciation of the equipment (with Operating Leases, you can expense the entire lease payment, rather than depreciation and interest). The interest deduction significantly reduces the overall cost of financing. The depreciation expense has a favorable impact on the capital equipment investment decision. Furthermore, with Section 179 tax deduction, you can depreciate up to $500,000 in equipment purchases in the year in which it is put into service. This special treatment can be particularly helpful to growing companies or as significant justification to make an equipment investment during periods of high profitability (i.e. reduce profitability through increased depreciation expense and therefore lower the tax burden).
There are tax advantages to both types of leases, you should consult your accountant to find out how the benefit will specifically apply to your situation.
Standard Equipment Financing Term:
Although there is some variability in the terms offered between equipment financing companies, their structures are generally quite similar.
- Down payment: For new ventures, 10-20% down payment is standard at the time that lease documents are signed. Businesses with 2+ years’ experience can get financing with very little or nothing down.
- Term: The most common term is 48 months, but can go to 60 months depending on credit profile. It can always be for a shorter period, but the cash flow impact is generally not favorable for earlier stage ventures.
- $1 Buy Out vs. Fair Market Value Leases: $1 Buyout leases are much like mortgage loans, with equal payments over the term with ownership of the asset transferring at the end of the lease period for $1. Fair Market Value Leases are similar to car leases in which there are smaller payments due over the term of the lease and an optional residual payment at the end of the term. For aesthetic equipment, this residual payment is generally equal to 10-15% of the purchase price and can usually be financed over the course of a few additional lease payments. Also, the buyer has the option of forgoing the residual payment and returning the unit to the distributor.
- Collateral: The collateral is the equipment.
Frequently Asked Questions:
The financing process can be a bit nebulous the first time. However, most of the questions are recurring and posted below for your reference.
- What documentation is necessary to apply for financing? The amount of documentation will vary depending on purchase amount and time in business. For higher purchase amounts, the following provides a comprehensive financing file: credit application, 2 years personal tax returns, 3 months personal bank statements, personal financial statement and purchase agreement. Additionally, established businesses will need to provide 2 years business tax returns and 3 months business bank statements. Physicians using the equipment in their normal course of business can often get approved with just a credit application, up to certain purchase price amounts (differs between companies, but up to $100k is not uncommon).
- I don’t think I can qualify based on my credit score. Many entrepreneurs express concern over negative marks on their credit report and believe that will preclude them from getting a finance offer. Credit score is a single metric in the credit profile and negative marks can be offset by any one or a combination of other factors that are often. For example, a well-developed business plan, liquidity, co-signers, cross corporation guarantees can all improve the overall credit profile.
- Can my business be a sole proprietorship or partnership? You will need to form an LLC or corporation to finance with an equipment finance company. This is usually a very straightforward process and done through the Secretary of State website.
- Will the loan or lease show on my personal credit report? Since the loan/lease is an obligation of your business, it will not show you your personal credit report.
- How does the finance process work and how long does it take? Once the required documentation file is submitted, finance terms can generally be presented in 24-48 hours. Once the term sheet is signed, the full finance documents are generated. When the finance docs are signed and conditions met (e.g. business address, proof of insurance, bank information), the finance company issues a Purchase Order to the distributor. This Purchase Order is the indication that the finance company will fund the purchase upon delivery and installation of the equipment. The entire financing process can be done in as quickly as a few days.
- When will my first lease payment be due? The lease/loan is triggered upon signing the Delivery and Acceptance form following delivery and installation. The timing of your first payment will vary depending on finance company and will be listed in the finance documentation.
- What if market demand does not meet expectations, can I return the equipment? The scope of most financing agreements is several years and encompasses full repayment of the equipment plus financing costs. Some equipment can be rented on a short term basis with lower level of commitment, however the cost is significantly higher. On an equivalent basis, renting a machine for a few days generally costs as much as a monthly lease/loan payment.
- If business exceeds expectations, can I pay off the loan or lease early? Finance companies make their initial credit decision based on the idea that all finance payments will be made. If an opportunity arises that allows for early repayment, many finance companies will provide a discount to the full remaining finance contract value, however this is generally not listed in the finance docs and is a discussion item with your finance company.
The Bottom Line:
Equipment financing is available for many credit profiles and makes good business sense for a number of scenarios. The process can happen very quickly and in conjunction with your timeline. High quality distributors and manufacturers can provide full service assistance to help you navigate this process in a manner that is most beneficial to your business.