Because the area of financing can be confusing, but crucial to the success of any business, let’s look at some of the dos and don’ts of financing when it comes to the embroidery industry.
Dos and Don’ts
- Do your homework.
- Conduct a market research study for your area.
- Do all the work necessary to create a comprehensive business plan.
- Decide which equipment best suits your needs to complete the business plan.
- Spend 1,500 hours preparing projections and proposals.
- Contact all financial institutions within a 2,000 mile radius.
- Send offerings to heaven of your choice.
- Don’t let the seemingly endless process deter you from your goal of owning the selected gear.
- Don’t take it personally when, after reviewing all your carefully prepared work, your hat and coat are handed to you and the door opened for you.
- Don’t take no for an answer!
Welcome to the wonderful world of finance. Once you’ve decided on the type of embroidery equipment, the address of your new business, and the location of your store, then comes the how. The how is the money part.
There are three ways to buy equipment:
- Cash
- Finance
- Rental
Even if you are in a position to pay in cash, it is sometimes wiser to keep as much cash as possible and fund anyway. This provides more backup capital for the initial period. What lenders are really looking for is as much stability as possible in a potential loan customer.
Here’s another reason to consider holding back some cash: You may need a working loan in a few months, if all. has already been applied to the machine, there will be no cash reserve to reassure the bank.
Unless the financial institution is highly experienced in the embroidery business, it will know nothing about resale values and will severely discount the value of your equipment when considering it for a loan.
So if you can’t, or choose not to pay in cash, you still have two possibilities: financing or leasing. These options also have their own advantages and disadvantages. Let’s start with the advantages of financing. First, you own the equipment (or at least that part of the equipment that the bank does not own).
You create an equity interest in the machine and therefore add it to the asset column on your balance sheet. With each payment, that equity increases. It also creates a liability on the balance sheet, but with each payment the liability decreases. At the end of a three or four year period, you are the full owner of the equipment, so 100 percent of its value goes to the asset column. Naturally, there has been some depreciation on the equipment, but it rarely comes close to its value at the end of the financial term. In our business, equipment maintains an extremely high value over the years. So try to own the equipment whenever possible and practical.
Another advantage of financing is that you can generally find lower interest rates at banks and credit unions than at leasing companies. In many cases, leasing companies borrow money from the same lenders that you might be targeting. To make money for the leasing company, add a percentage to the interest rate on the transaction. Even where the leasing company is so large that it uses its own money, the interest rate is usually about the same as that charged by smaller leasing companies. It is possible to look for more favorable interest rates on leases if you currently own a business and have operated it for at least two years. If you have sterling business credit, you may be able to get a pretty good rate from a company that does your own funds, rather than one that manages funds on your behalf.
Some advantages of leasing are lower entry costs, tax benefits (ask your accountant), and the fact that it is sometimes easier to qualify for a lease program than it is to qualify for conventional financing for such a large amount. The downsides are higher interest rates and sometimes higher payments. Also, at the end of the lease period, you are not the automatic owner of the equipment. Let’s take a closer look at these factors.
One of the biggest advantages of leasing is the lower entry costs. While a bank generally looks for a 20% or 30% down payment, a leasing company generally looks for the first and last payment, and perhaps an additional month’s payment as a security deposit.
In some cases, an agreement that a leasing company is not comfortable with can be strengthened with an additional equity deposit. For example, what if instead of providing the first and last payment, plus an additional month as collateral, you offer a security deposit equal to six monthly payments? Or maybe a year’s payments? An easy way to provide such a security deposit is to post a certificate of deposit from your bank. If you have such an investment, you can pledge it to the leasing company as collateral for your lease and still earn and receive the interest. The leasing company is covered, its security requirement is minimal, and it still receives the interest.
One concern here is that in some cases, when a large amount of money is committed to a lease, the transaction becomes a purchase rather than a lease and may be treated differently from a tax point of view. The main reason you want the IRS to treat the lease as a true lease, rather than a financed arrangement, is that the monthly lease payments are deductible as a business expense. Loan payments are not deductible, only the interest paid each year is deductible. Of course, in a direct purchase, there are different tax benefits, such as investment tax credits. These can be significant, however they must be repaid when the equipment is sold because the sale results in a capital gain. This is a complex area and every situation is different. Talk to your accountant about which avenue is best for your situation. If you don’t have an accountant, consider consulting one on such important issues as this.
At the end of the lease term, you have the option of returning the equipment to the leasing company or paying $ 1 to 10 percent of the original cost of the equipment (or its fair market value) to purchase it. Be careful here, because if the purchase residual is too low, the IRS may treat the transaction as an arrangement or financed purchase, rather than a lease.
Another point to remember is that we are talking about leasing embroidery equipment, not cars or farm equipment. Some leasing companies specialize in certain types of businesses and know the resale value of equipment.
You go into a business with every expectation of success, but the bank or leasing company is looking at you from the point of view that if it fails, it must limit its exposure to the downside. How much can you get for the machines if you can no longer make payments? A leasing company that is unfamiliar with embroidery equipment might assess the resale value of a machine at 10 cents on the dollar, while a company with experience in this business would use a valuation of 50 cents on the dollar.
If your proposed equipment package includes scanning equipment, you should inquire about the potential leasing company’s policy regarding software. Most leasing companies place a limit on the dollar amount of software value in a deal. This varies widely, but the value of the software is generally limited to between 20 and 50 percent of the total lease package.
No matter what you do, make sure you are well prepared when approaching a financial institution to apply for a loan for your machine. Make sure you can answer all the questions with confidence. These questions will undoubtedly include some of the following: Do you have a business plan? What experience do you have in owning a business? Why do you think your business will be successful?
There must be some kind of rule of thumb in the banking or leasing business that no matter how many documents the client brings to a first and second meeting, a loan cannot be arranged until the client has been to the office at least three times! ! Joking aside, there is no alternative to being prepared, and it may take a lot of field work to find the deal that works for you.
Other sources that are emerging in the world of finance are government programs and economic development council (EDC) programs. Don’t overlook these possible sources of machine financing. Small Business Administration loans administered through banks can be difficult to obtain, but those who qualify are rewarded with low interest rates and favorable terms.
There are other programs available in some areas from the regional or municipal economic development councils known as Revolving Loan Funds. Here’s how they work: The borrower must provide 15 percent of the total transaction from their own funds. The balance of the deal is divided between the EDC and a participating bank. The bank generally lends its half at 2 percent above the prime rate, while the EDC provides its funds at 2 percent below the prime rate. Here, you may have the best deal. Your down payment liability is only 15 percent and you are borrowing the most. (Donald Trump can’t borrow at best!) Terms are typically 4-5 years, and there is no prepayment penalty.
Financing your own equipment may not be fun, but it is a necessary part of get into the embroidery business. Be resourceful and research all available avenues before jumping into a deal that might not be right for you. The long-term financial well-being of your new business is at stake. Take the time to find the arrangement that best suits your needs, so that it is a real pleasure to have the equipment that you finally buy.