Equipment Financing

Equipment represents another asset of the firm that may be pledged to secure a loan. If the firm either has equipment that is marketable or is purchasing such equipment, it is usually able to obtain some sort of secured financing. Because such loans usually are for more than a year, we classify them as intermediate term financing. As with other secured loans, the lender evaluates the marketability of the collateral and will advance a percentage of the market value, depending upon the quality of the equipment. Frequently, the repayment schedule for the loan is set in keeping with the economic life of the equipment. In setting the repayment schedule, the lender wants to be sure that the market value of the equipment always exceeds the balance of the loan. ¬

The excess of the expected market value of the equipment over the amount of the loan is the margin of safety, which will vary according to the specific situation. The rolling stock of a trucking company is movable collateral and reasonably marketable. As a result, the advance may be as high as 80 percent. Less marketable equipment, such as that with a limited use, will not command as high an advance. A certain type of lathe may have a thin market, and a lender might not be willing to advance more than 50 percent of its reported market value. Some equipment is so specialized that it has no value as collateral. Frequently, the lender either will have its own appraiser or will hire an appraiser to estimate the approximate value of a piece of equipment if it has to be sold. As with other collateral, the lender must know not only the estimated market price of the equipment but also the cost of selling it.

Sources of Equipment Financing. Commercial banks, finance companies, and the sellers of equipment are among the sources of equipment financing. Because the interest charged by a finance company on an equipment loan is usually higher than that charged by a commercial bank, a firm will turn to a finance company only if it is unable to obtain the loan from a bank. The seller of the equipment may finance the purchase either by holding the secured note itself or by selling the note to its captive finance subsidiary. The interest charge will depend upon the extent to which the seller uses financing as a sales tool. The seller who uses financing extensively may charge only a moderate interest rate but make up for part of the cost of carrying the notes by charging higher prices for the equipment. The borrower must consider this possibility in judging the true cost of financing. Equipment loans may be secured either by a chattel mortgage or by a conditional sales contract arrangement.

Chattel Mortgage. A chattel mortgage is a lien on property other than real estate. The borrower signs a security agreement that gives the lender a lien on the equipment specified in the agreement. In order to perfect the lien, the lender files a copy of the security agreement or a financing statement with a public office of the state in which the equipment is located. Given a valid lien, the lender can sell the equipment if the borrower defaults in the payment of principal or interest on the loan.

Conditional Sales Contract. With a conditional sales contract arrangement, the seller of the equipment retains title to it until the purchaser has satisfied all the terms of the contract. The buyer signs a conditional sales contract security agreement to make periodic installment payments to the seller over a specified period of time. These payments usually are monthly or quarterly. Until the terms of the contract are satisfied completely, the seller retains title to the equipment. Thus the seller receives a down payment and a promissory note for the balance of the purchase price upon the sale of the equipment. The note is secured by the contract, which gives the seller the authority to repossess the equipment if the buyer does not meet all the terms of the contract.

The seller may either hold the contract or sell it, simply by endorsing it, to a commercial bank or finance company. The bank or finance company then becomes the lender and assumes the security interest in the equipment. If the buyer should default under the terms of the contract, the bank or finance company could repossess the equipment and sell it in satisfaction of its loan, Often the vendor will sell the contract to a bank or finance company with recourse. Under this arrangement, the lender has the additional protection of recourse to the seller in case the buyer defaults.