Equipment loans are used for financing a wide variety of equipment such as agricultural equipment, construction equipment, and even equipment working in a factory. This post will discuss equipment loans that fall outside of the Canadian Agricultural Loans Act (CALA) program or the Canada Small Business Financing Act (CSBFA).

Equipment loans have regular instalment payments matched to the business’s cash flow cycle. The repayment period (amortization) on the loan is matched to the economic life of the equipment being financed. These loans will take the equipment being financed as collateral. The bank will not lend the full amount of the purchase but rather 50% to 75% of the purchase price. The lending value is determined by the age and marketability of the equipment. The discounted lending value is meant to protect the bank against the inevitable depreciation of the equipment. The bank wants to make sure that the collateral is always worth more than the value of the loan.

These loans come with fixed or floating rates. Floating rates are based off of the prime lending rate with spreads of 1% or more, depending on the creditworthiness of your business. Fixed rates for equipment are generally higher than mortgage rates. Prepayment of a fixed rate equipment loan may not be allowed or may cause stiff prepayment penalties but this varies from bank to bank.

Dealer financing for equipment can generally be done at 100% of the purchase price. They do this because it is much easier for them to repossess equipment and sell it than it is for the bank, which does not operate a dealer network. Dealer rates may appear to be lower but watch for documentation fees or setup fees that can create an effective rate of interest that is close to that of your financial institution. A dealer may not give the same amount of a discount off of the purchase price for a deal they finance in house compared to a cash purchase. This also adds to the cost of borrowing.

Financing equipment can get complicated so I recommend that you shop around for your financing. Make sure you compare the total cost of borrowing of the various options that are available. Leasing equipment is another possibility. I’ll cover that in a future post.

The Canadian Small Business Loans Financing Act (CSBFA) is a Federal Government program that is meant to make it easier for small businesses to access the money they need to grow. This program provides a level of insurance against default by the borrower, which protects the lender. The insurance is provided by the Federal Government and is administered by the banks. CSBFA insured loans are available to businesses that have less than $5 million in gross annual revenues. A business can have a maximum $500,000 of these loans outstanding at any given time, with a maximum of $350,000 tied up in equipment or leasehold improvements.

Examples of eligible items include:

• buildings and land
• commercial vehicles
• hotel or restaurant equipment
• computer or telecommunications equipment and software
• production equipment

Ineligible items include:

• goodwill
• working capital
• inventories
• franchise fees
• research and development

The advantage of this program over normal financing is that 90% of the purchase price of eligible items can be financed. A bank would finance a much lower percentage of the purchase price if the loan wasn’t insured. There is a cost for this increased level of financing however, as the government requires 2% of the loan amount as an insurance premium. This can be financed as part of the loan. Interest rates are higher compared with other loans with floating rates at prime plus 3.0% and fixed rates at the bank’s residential mortgage rate plus 3%. A portion of this interest is paid to the federal government as part of the insurance premium.

Collateral for the loans is the assets being financed. If you are borrowing through a company, the bank can request a personal guarantee in amount up to but not exceeding 25% of the loan amount.

Detailed receipts must be provided for all items and services being purchased as the bank must prove that only eligible costs were financed. This can be quite a hassle, especially in the case of leasehold improvements which can create a lot of receipts for materials and labour.

CSBFA loans can be a good source of funds for the first time entrepreneur because the higher financing percentage means that less start up capital is required. It’s important to shop around for a CSBFA loan. Some banks don’t have a desire to do these loans due to the increased administration required. Make sure that you find a bank or credit union that is enthusiastic about the program and does a reasonable volume of CBFA loans. It takes some expertise to approve and set up these loans so it is best to deal with an Account Manager that has a lot of experience with them.