Equipment Financing Helps Build Profitable Construction Businesses

When residential, commercial and public sector buildings are on the upswing and contractors find themselves taking on more projects, many construction business owners find themselves in need of new or updated equipment to meet increasing demand.

Even during the best of times, however, there are several factors that should be weighed before making an equipment purchasing decision.

Like most construction business owners, John Ring, president of Tennessee Contractors, Inc., has learned from experience when the time is right for new equipment. Having been in the construction business all of his life, Ring has developed a knack for determining what equipment he needs when and perhaps more importantly, what kind of financing makes the most sense in each situation.

“A lot of variables factor into a decision to get a new piece of equipment,” said Ring, whose company focuses primarily on residential construction. “Demand, which can vary seasonally, what kind of jobs we have lined up and how many hours we have on our existing equipment all have to be taken into consideration when deciding whether to add or upgrade equipment.”

Another big factor to consider is how to structure financing for each piece of equipment in order to maximize profit. For example, Ring’s current fleet of vehicles includes ten trackhoes, two bulldozers and two backhoes, to name a few. Ring owns some of his equipment, some is leased, and he rents a few pieces that are primarily used in the summer.

“Ultimately, I like to own most of my equipment, but there are specific times when it makes more sense to rent, and leasing gives me the flexibility to pay for equipment over time and still have the option to purchase it at the end of the lease,” said Ring. “It’s important to get as much profit as I can out of each piece of equipment, so we weigh all of our financing options very carefully.”

The Benefits Add Up

There are many benefits to equipment financing, such as giving contractors access to the equipment they need when they need it without a large outlay of cash. Equipment financing can help contractors respond quickly to new jobs with minimal documentation and red tape; often, credit applications can be approved within an hour.

Some finance packages include extended warranties, insurance and maintenance, which add value for contractors by enhancing buying power, offering greater flexibility and providing convenience. Others make it easy to add or upgrade equipment as needed, and all financing options make it easier for contractors to accurately forecast the cash requirements for equipment.

Equipment financing is a strategic business decision and should be considered carefully. Because factors such as cash flow, interest rates, tax status and equipment use are important parts of the equipment financing equation, it is best to include an accountant or tax advisor in the decision-making process.

Regardless of the size of the construction company or the type of equipment needed, one thing is certain: There are a wide variety of equipment financing choices. From leases and loans to rental and outright purchase options, it is important to do your research before signing on the bottom-line.

Rental Purchase Agreement

In today’s interest rate environment, one of the most popular finance options among contractors is the rental purchase agreement. With a rental purchase agreement, the contractor rents the equipment either month-by-month or for a predetermined amount of time, typically between three and twelve months. In many instances, a portion of each monthly payment accrues as equity in the equipment, which can be used toward the purchase of the machinery at the end of the rental agreement.

With a rental purchase agreement, a contractor can obtain a new piece of equipment, often with just an advance monthly payment and the liability of the rental length.

“A rental purchase agreement is a great option for a contractor who needs a piece of equipment to start a job that hasn’t yet generated any revenue,” said Jim McNeillie, vice president of finance at Power Equipment Company. “This gives the construction company a chance to try out the equipment with the option to purchase it at the end of the rental, using some of the money they’ve already paid in rent toward their purchase.”

Lease Options

As interest rates continue to rise, equipment leasing will become more and more popular among construction business owners. Equipment leasing is another valuable financing option that allows contractors to maximize their purchasing power without a large, upfront cash investment.

“If I want to spread out the cost of a $300,000 piece of equipment over a longer period of time, a lease will cost me less in the long run than other options, and it gives me more cash flow while I’m using that piece of equipment,” said Ring.

The two most common types of leases are the capital lease and the operating lease. The capital lease is ideal for the contractor who is interested in purchasing the equipment at the end of the lease agreement, whereas the operating lease works better for those interested in returning the equipment at the end of the term.

The two most common types of leases are the capital lease and the operating lease. The capital lease is ideal for the contractor who is interested in purchasing the equipment at the end of the lease agreement, whereas the operating lease works better for those interested in returning the equipment at the end of the term.

The capital lease, also known as a finance lease or conditional sale, provides the widest flexibility of term length, which can help keep payments low. Capital leases also provide a variety of tax benefits, including the ability to write-off depreciation and interest expense for the acquired equipment. With a capital lease, each monthly payment contains both interest and principal.

At the end of the lease period with a capital lease, there are a variety of options for next steps. The contractor can choose to purchase the equipment at a price below the current fair market value (FMV)-often $1-or the lease can be renewed at a fixed price.

With an operating lease, or an “off balance sheet lease,” terms are typically shorter than capital leases, and the equipment acts more like a rental. This means the payment does not appear on the company balance sheet. When the term expires, companies may return the equipment, or purchase it at FMV.

“Some of our customers like the operating lease option because it allows them to get new equipment every few years. They use the equipment for a set period of time, then turn it back in at the end of every lease term for a brand new piece of equipment,” said McNeillie.

Taking the Next Step

After identifying an interest in equipment financing, the next step is choosing a finance partner. Construction business owners can often rely on their dealer, an equipment manufacturer or an independent finance company to provide a variety of finance options.

Many dealers, like Power Equipment Company in Knoxville, TN, take the legwork out of finding financing by offering it as part of the sales process. If a specific equipment dealer does not offer a financing option, it may be worth shopping around for one that does.

“In today’s climate, construction equipment is expensive. Most contractors don’t have the cash available to purchase a piece of equipment, and even if they do, it doesn’t always make the most sense financially,” said McNeillie. “More than 85 percent of our customers take advantage of the financing options we provide. For most of them, it’s just an automatic part of the process.”

Because equipment dealers have developed relationships with a number of independent finance companies, they can typically provide a finance option to meet almost any need. Power Equipment Company, for example, can offer skip payments through slower construction seasons, or high-low payments, where a construction business owner pays higher monthly payments during busy summer months and lower payments during the winter for customers who qualify. The company can also offer a wide range of terms, or allow a contractor to pay a down payment on equipment with several installments.

“We sit down with each customer to make sure we understand their business before recommending a finance option,” said McNeillie. “Once we have a better understanding of the complete scenario-from how they plan to use the equipment and what their cyclical fluctuations look like, to their cash flow situation and current interest rates-we help them structure a finance program that suits their needs.”

Since joining Power Equipment in 1982, McNeillie has helped Ring make most of his equipment finance decisions.

“I usually have a pretty good idea about what I want, but Power Equipment makes it really easy to sort through all of the details,” said Ring. “Ultimately it’s my decision, but it’s nice to have a finance expert on hand to help guide you through the process.”

Captive Leasing

To make it easier for contractors to purchase their equipment, many manufacturers offer financing through their equipment dealers, often called captive financing. Minnesota-based Mustang Manufacturing Co., Inc., for example, partners with a leasing company to offer a variety of leasing options to fit a customer’s budget.

“We want to make it as easy as possible for contractors to purchase Mustang compact construction equipment,” said Doug Snorek, Mustang marketing manager. “By offering our own leasing and financing programs, we’re providing one-stop-shopping for equipment and financing, regardless of whether or not the dealer has a finance program. Also, contractors doing business in different parts of the state-or even in multiple states-can get the same financing deals regardless of what Mustang dealer they use.”

Independent Leasing Companies

Although many dealers and manufacturers provide easy access to financing, some construction companies prefer to shop around for their own finance partner.

Many independent finance companies are owned by large, national banks, which give them greater access to capital and the ability to offer a wide variety of financial services, such as loans, lines of credit, checking accounts and investment options.

One important consideration is the financial strength of the finance company. Keep in mind that you will be entering into a potentially lengthy relationship with this company, and you want to be sure they’ll be there as a long-term business partner. It is also important to select a finance partner that has experience with the construction industry, is familiar with the equipment and has worked with companies with similar needs to yours.

Like a dealership that provides financing, a good independent finance company will take the time to get to know your business objectives before making a recommendation and should be able to provide quick, no-hassle credit approvals. Some finance companies even have a team of experts dedicated to providing equipment financing for the construction industry, specifically.

Finally, before selecting a finance partner, ask for a list of references. Check with current customers to make sure someone from the finance company will be available to answer questions or provide additional guidance through the duration of the partnership if necessary.

To aid companies in the search for a leasing company, the Equipment Leasing Association, a non-profit association representing companies involved in the equipment leasing industry, has developed a tool called Choose Leasing, available at www.chooseleasing.org  Choose Leasing answers commonly asked questions about financing, discusses important things to note before signing a contract and offers a search engine for finding nearby or specialty finance companies.

Jeff Gocken is national sales manager of Key Equipment Finance’s construction and industrial segment. He has more than fifteen years of experience in the equipment finance industry. Key Equipment Finance is one of the nation’s largest bank-affiliated equipment leasing companies. Gocken can be reached by phone at 630.874.5915, or visit www.kefonline.com.

Construction Business Owners, September 2006