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Can you use a business line-of-credit to purchase big-ticket equipment?

Posted By Julie Smith, Horizon Community Bank, Tuesday, July 26, 2016

New phone systems, specialized machinery, software with a hefty price tag, bulldozers or fleet vans… sooner or later, many businesses need to invest in some form of equipment.

It’s a natural progression as a business grows and ages.

For many, the knee-jerk reaction is to use an “already available” line of credit or operating capital loan to buy the needed equipment. It’s sitting there pre-approved and waiting to be used, the interest rate is reasonable and it saves time… it seems like an easy answer.

While it may be as simple as writing a check, a line of credit might not be the best financing solution for new equipment purchases, however. It pays to think through alternatives and the long-term impact of each one.

LACK OF A FIXED TERM AND INTEREST RATE

Line of credit loans can have very attractive interest rates, but typically it’s not a fixed rate. It can flex based on the market at the time you borrow against the line of credit, so a major purchase might lead to a higher payment than you expect.

It also can flex based on the amount borrowed. If you use it to purchase equipment then need to withdraw funds to cover a payroll shortfall that pushes you over the borrowing limit, for example, your interest rate could increase substantially.

Even a single late payment can have a serious impact, turning a once low-interest loan into an expensive liability with years of payments remaining before the new equipment is paid off.

The variable rate on a line of credit can be very different than a fixed term loan, where a late payment might result in a one-time fee but won’t impact the interest rate.

Not only are the terms less friendly for this kind of expensive purchase, but you’re giving up the “insurance” of having readily available funds to draw on for immediate needs.

GOODBYE, SAFETY CUSHION

Most open a line of credit to have funds available if needed, which can then be paid down and re-used as needed. Unlike a fixed term loan that is paid off then closed, a line of credit is designed to be flexible as business needs ebb and flow. It remains open. If you use it to finance high-ticket items like equipment, your safety cushion is no longer available for unexpected emergencies, such as a payroll shortfall or holiday inventory needs. It can take years to pay off the balance.

Plus, once you’ve borrowed against the line of credit to its limit, there’s no guarantee a bank will be willing to risk lending additional funds if you have an emergency. You’ve backed yourself into a corner.

SHORT-TERM LOAN VS. LONG-TERM DEPRECIATING ASSET

Lines of credit are intended to be a short-term solution to a financing need. They’re also intended to be paid off quickly, much like a credit card. Using it to pay for expensive items that require longer terms to pay off and depreciate slowly might not make financial sense.

As a general rule-of-thumb, it’s a good idea to match short-term financing resources to pay for short-term needs, and long-term resources to pay for long-term needs. Here’s an example. If you need $30,000 for equipment that would have an expected lifespan of five years—say a new set of computers for your team of 18 graphic designers–and your business revenue would require around the same length of time to pay off that balance, financing it through a separate fixed rate loan would be a much better option than using a line of credit.

Not only is the line of credit free for other things, but matching your cash flow to how long something is expected to benefit your business makes sense. It helps you manage your cash flow effectively without draining cash reserves to make a monthly payment or reaching your borrowing limit.

SHOULD YOU CONSIDER LEASING THE EQUIPMENT?

Financing options for equipment aren’t limited to an outright purchase. If a start-up or small business doesn’t have the creditworthiness or profit margin that a bank requires, if the equipment loan dollar amount is high enough to exhaust its borrowing capacity, or if the equipment will require replacement in less than three years due to obsolescence, leasing can be a solid choice.

It results in a less expensive monthly payment and can offer opportunities to purchase, return, exchange or renew the lease on equipment once the original term ends. It also has a completely different impact on your company financials. An equipment purchase shows up on your balance sheet and may have deductible interest, but a lease payment is likely to be 100% deductible as an operating expense. Smart business owners might consider speaking with their tax attorney or accountant before making a lease versus purchase decision, along with bankers and lenders.

Obtaining multiple quotes on a leasing arrangement is also wise from a down payment and term perspective. If considering a non-bank lender, terms can vary drastically due to a general lack of regulation in their industry (compared to banks), and shopping your purchase can be very enlightening.

It’s also helpful to discuss different lease formats, such as a capital lease versus an operating lease. Each has a different impact on your bottom line and balance sheet.

QUESTIONS TO ASK BEFORE YOU DECIDE

According to William Sutton, president and CEO of the Equipment Leasing & Finance Association (ELFA), these ten questions can help you decide if a lease or purchase is your best option. While it’s not an exhaustive list and speaking to a banker is suggested, it’s a great place to begin.

  1. How long will the equipment be required?
  2. What is your monthly budget?
  3. Will the equipment become obsolete?
  4. Can it be used for other projects?
  5. How much cash is required upfront?
  6. Who receives the tax benefit?
  7. How will a working-capital facility be impacted?
  8. How flexible are the financing terms?
  9. Is additional equipment anticipated?
  10. Who can help determine the best option?

 To get more information about equipment funding alternatives and right finance options that fit your specific needs, visit a Horizon Community Bank branch today, or call to make an appointment with one of our loan officers. We’re committed to your business success!

Tags:  assets  lending  loan  small business loansmall business 

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Should You Make Your Business an LLC?

Posted By Rhette Baughman, Arizona Small Business Association, Monday, June 16, 2014
Updated: Wednesday, August 13, 2014

If you are launching a new business, you may want to consider forming a separate entity such as a corporation or LLC, to protect your personal financial life.

The legal form of your business brings different tax implications. When forming an LLC, you receive the benefits of creating a separate entity and thus protecting your personal assets.

When it comes to taxes, however, the IRS has no tax return for an LLC per se. You may treat the LLC as a C or S corporation, partnership or sole proprietorship and file accordingly. Your state taxing agency may have a special set of LLC tax forms for your entity to file.

Entity selection is not something to rush into without first consulting a good business attorney and tax professional.

While the internet is a great resource, there are many error-filled websites offering bad advice that can be costly down the road and land you in hot water with the IRS.


There are many things to consider when choosing a business entity. First of all, if you have no assets to protect and a good insurance policy, you may be fine operating as a sole proprietor. But this is something that must be discussed with an attorney to protect your personal finances.

Your company’s success and reputation does not hinge on how it’s classified, and employee benefits are deductible by all business entities. However, the only way to ensure the deductibility of benefits paid to an owner/shareholder is to incorporate as a C corporation. An LLC can elect to be treated as a C Corporation for tax purposes and therefore enjoy this benefit.

Another benefit of becoming an LLC is that you free yourself from personal liability for corporate debt. However, in the real world, lenders seek personal guarantees for corporate debt.

When setting up a separate entity, one must consider the cost. There will be a separate charge for income tax preparation, usually a minimum state franchise tax and filing fees upon formation.
Currently Illinois charges $500 to form a LLC, the highest filing fees in the nation. Eliot Richardson, founder of The Small Business Advocacy Council (SBAC), has been working to pass legislation in Illinois to lower LLC Fees from $500 to $39 and for series LLCs from $750 to $59. The filing fee for a corporate structure in Illinois is only $150 by comparison.

Richardson testified at a hearing last Wednesday in Springfield, IL with disappointing results. The bill had already passed through the senate but the house stalled on reducing the filing fee. No further hearings are planned.

Richardson stated in his testimony, “Some business owners may elect corporate status simply because the fee is lower, when really their best choice is the LLC structure."

Originally published at FOX Small Business. Written by Bonnie Lee.
Photo Credit: The Waving Cat via PhotoPin CC

Tags:  assets  c corp  LLC  s corp  small biz  small business  starting business  startup  tax  taxes  tips 

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