What Is an Equipment Finance Agreement?

An equipment finance agreement is a contractual arrangement that allows businesses to acquire necessary assets without a large upfront capital expenditure. This type of financing is a common method for companies across various industries to obtain machinery, vehicles, and technology. It enables businesses to secure the tools they need to operate and grow, spreading the cost over a defined period.

Understanding Equipment Finance Agreements

An equipment finance agreement (EFA) is a legally binding contract that facilitates the acquisition of tangible business assets. It enables companies to obtain essential machinery, vehicles, or technology without depleting working capital through an immediate, full purchase. The agreement typically involves two main parties: the borrower or lessee, which is the business acquiring and using the equipment, and the lender or lessor, the financial institution providing the financing. EFAs are commonly used for a wide range of tangible assets, including manufacturing machinery, construction vehicles, office technology, and medical devices. The agreement details conditions for equipment use, payment schedules, and whether the business will gain ownership or return the equipment.

Essential Terms and Conditions

An equipment finance agreement includes various provisions that define the obligations and rights of both parties.

Agreement Term: Specifies the contract duration, commonly 24 to 60 months, though longer terms up to 10 years are possible.
Payment Structure: Outlines how payments are scheduled, typically monthly, and whether they are fixed or variable. Payments usually consist of principal and a finance charge.
Interest Rate or Lease Rate: Determines the cost of financing. For loans, this is a stated interest rate; for leases, it is embedded within the lease rate factor.
Collateral and Security Interest: The equipment serves as collateral, meaning the lender holds a lien on the asset until the agreement is fulfilled.
Default Clauses: Specify conditions for a breach, such as missed payments. Consequences can include repossession or acceleration of outstanding payments.
Maintenance and Insurance Obligations: Assign responsibility for keeping the equipment in good working order and adequately insured, usually falling to the borrower or lessee.
Purchase Options or End-of-Term Provisions: For leases, these detail choices at contract conclusion, such as buying the equipment, renewing the lease, or returning the asset. For loans, the lender releases its lien upon full payment, and the borrower retains ownership.
Representations and Warranties: Standard legal assurances made by both parties regarding information accuracy and capacity to enter the agreement.

Loan Versus Lease Structures

While “equipment finance agreement” is a broad term, it generally refers to either an equipment loan or an equipment lease, each with distinct characteristics. Both options allow businesses to acquire necessary assets and spread costs over time. The fundamental difference lies in ownership versus usage rights.

Equipment Loan

With an equipment loan, the borrower takes immediate legal ownership of the equipment upon purchase. The lender holds a security interest or lien on the equipment until the loan is fully repaid. Payments typically comprise principal and interest. The acquired equipment is recorded as an asset on the borrower’s balance sheet, and the business recognizes depreciation expenses over its useful life.

Equipment Lease

An equipment lease means the lessor retains legal ownership of the equipment throughout the lease term. The lessee pays for the right to use the asset for a specified period. Leases are categorized as operating or finance leases, differing in how ownership risks and rewards transfer to the lessee. Operating leases function like rental agreements, while finance leases transfer more ownership-like characteristics. At the end of a lease term, common options include returning the equipment, renewing the lease, or purchasing it.

Navigating the Agreement Process

Securing an equipment finance agreement involves preparatory actions and procedural steps.

Preparing Your Application

Businesses first gather essential information for the application. This includes detailed specifications and the exact cost of the equipment. Businesses also compile financial statements, such as income statements and balance sheets, alongside recent tax returns. Business registration documents, credit history, and a description of the equipment’s projected use are also standard requirements.

Application and Approval

Once information is compiled, the application is submitted. This can be done online, directly with a lender, or via a financial broker. The application undergoes review and approval, including underwriting and a credit assessment. The lender evaluates the business’s financial health and ability to repay, providing an approval or denial.

Post-Approval and Term Management

Upon approval, agreement documents are signed, and funds are disbursed directly to the equipment vendor. During the agreement term, ongoing management involves making timely payments, adhering to covenants, and fulfilling maintenance and insurance obligations. At the conclusion of the term, for loans, the borrower receives a lien release. For leases, the business exercises one of the end-of-term options.