Introduction
Asset financing is frequently used by businesses to access the use of equipment, with either the intention of owning it at the end of the agreement or returning it under a lease arrangement.
In this article, we will examine the various types of asset finance available, the types of equipment that can be financed, and the benefits of utilising asset finance.
If your business is looking to acquire or gain access to equipment without incurring hefty upfront costs, asset financing could be a valuable tool in your financial arsenal.
What is Asset Finance
Asset financing refers to a specific set of financing arrangements that enable businesses to acquire equipment and vehicles without paying the entire cost upfront.
Instead, the borrower would pay an initial deposit (e.g. 10% of the purchase price) with the remainder of the costs spread over a pre-defined term, suited to the proposed borrower’s requirements, with the option to either own the asset outright at the end of the agreement (subject to any final balloon payments and fees) or to return the asset.
Unlike traditional secured lending, the asset itself is used as security for the loan (rather than, for example, a house), with the repayment terms structured around the helpful life of the asset. Should the borrower be unable to fulfil their obligations under the agreement, the lender can reclaim the asset.
Given the substantial market for asset financing, with lenders capable of financing a wide range of equipment, this area is particularly versatile, offering options tailored to suit the borrower’s circumstances. Although this can lead to competitive deals for borrowers, it can also make navigating the market more challenging.
Types of Asset Finance
There are various forms of asset finance, each serving different purposes. Below, we look at some of the key features of these methods:
Hire Purchase
Hire purchase (“HP”) agreements involve the borrower “hiring” the asset for the term of the contract. At the end of the term, the borrower can opt to take full ownership by paying any balloon payments or outstanding fees.
Hire purchase agreements can be tailored to fit the borrower’s requirements. For example, if they would like to make smaller monthly instalments, this can be facilitated by increasing the final balloon payment. Alternatively, if a borrower’s cash flow allows them to service larger monthly repayments, they can then pay a smaller balloon payment at the end of the agreement.
Finance Lease
Finance leases involve a funder acquiring an asset and leasing it to the borrower/lessee, who makes regular payments over an agreed term. The key difference between a finance lease and a hire purchase agreement pertains to ownership.
At the end of a finance lease, the business can negotiate an extension of the lease, return the asset to the lessor, or purchase the asset. Alternatively, the company can also negotiate a sale on behalf of the lessor. This can provide flexibility at the end of the agreement without requiring the purchase of the asset.
Operating Lease
An operating lease enables a business to obtain short-term access to an asset without assuming ownership of it.
The key difference between an operating lease and a finance lease is that an operating lease typically lasts for a specific period, which is usually shorter than the asset’s useful economic life.
This can be particularly useful where a company wants to use an asset for a considerably shorter period than its total useful economic life and does not want to incur the costs of acquiring the asset outright.
It should also mean that the rental payments are lower, given that the asset will have a higher residual value upon its return to the lessor.
Another key difference is that with operating leases, the responsibilities of ownership, such as insurance and keeping the asset in good repair, usually remain with the lessor. On the contrary, with a finance lease, the responsibilities associated with ownership often lie with the lessee (the business using the asset).
HP & Leaseback (Asset Refinance)
A Hire Purchase & Leaseback agreement (also known as asset refinance) serves a different purpose altogether.
Instead of being designed to allow businesses to access and use assets they do not already own, asset refinancing will enable businesses to release cash from assets they already own.
What Can Be Financed?
Asset financing can be used to fund the purchase of a wide range of equipment, machinery and vehicles.
In theory, almost any sellable asset with a value can be financed, and different lenders will often have their preferred types of assets. For example, some lenders may have a strong appetite for agricultural machinery and vehicles, whereas others may specialise in marine asset financing.
Hard assets, such as machinery, printers, vehicles, boats, and renewable energy infrastructure, are commonly financed along with soft assets, including computer system software.
Benefits of Asset Finance
The benefits of using asset financing can be broad, with one of the most obvious being that it allows businesses to access and use equipment that they may otherwise not be able to afford due to the hefty upfront costs. This can increase the output for their business and aid growth.
Even if a business can afford the initial costs, opting to finance them can free up cash flow for other business activities, such as research and development (R&D).
In addition, as the collateral for the debt is the asset itself, it can be an attractive option for businesses who may not have other assets to put forward as security.
In relation to operating leases, a significant additional benefit for the business is that it will only have to pay for the lease during the period in which it uses the asset. This can be particularly useful in areas that evolve quickly, such as IT, where updates and upgrades can leave old systems obsolete.
Drawbacks
Like any debt financing involving the securitisation of an asset, the asset in question can be repossessed. This can be a particular problem where the equipment is a vital part of the business’s operations.
In addition, in certain circumstances, the lessor/lender may include restrictions on the use of the asset during the term of the agreement. An example of this can be the maximum number of miles a vehicle can be driven in a year.
It’s also essential to ensure the agreement in question is flexible enough to suit your needs. For example, some lenders may not allow borrowers to sell and upgrade the assets that have been financed during the term of the agreement. This could become problematic if the company’s requirements change.
Is Asset Finance right for Your Business?
Asset financing can be an excellent option for businesses to acquire new kit and fuel growth whilst managing cash flow. It can be beneficial when the business is looking to invest its cash in alternative work streams, but still requires essential kit for operations.
If businesses have high capital commitment requirements or believe that immediate asset acquisition will help fuel growth, asset financing may be a suitable option for them.
It can also be beneficial for smaller companies that need new equipment to compete with larger firms.
In terms of specific industries, areas such as transportation, healthcare, agriculture, construction and hospitality, to name a few, commonly use asset finance as they often require large and expensive equipment for vital business operations.
How a Broker Can Help
The asset financing market is diverse. There is a wide variety of lenders, each with its own different niches and preferences.
Although such a market can lead to good competition and competitive rates for borrowers, it can also make it a daunting market to navigate.
It’s also prudent to note that lenders’ appetites can change relatively frequently, which can significantly impact their pricing on debt.
A broker, such as Clever Commercial Finance, can analyse the market and provide options to get a good idea of what is available. They can then negotiate favourable terms on your behalf and ensure the structuring of the financing suits your needs by, for example, ensuring any payment profiles match a business’s cash flow.
Additionally, when applying for a loan, there may be numerous industry terms that are not immediately understandable. A broker can help clarify this language, ensuring you are clear and informed about what you are signing up for.