Disadvantages of Asset Finance
Important considerations when choosing asset finance.
While asset finance offers significant advantages, it is important to understand the potential drawbacks and limitations before entering into an agreement. An informed decision \u2014 weighing both benefits and considerations \u2014 ensures you choose the right product and structure for your specific circumstances.
Key Considerations
Total Cost of Ownership
Over the full term of an asset finance agreement, the total amount paid will exceed the outright purchase price. The finance charge (interest) represents the cost of spreading payments over time. However, this must be weighed against the benefit of preserving working capital and the time value of money.
Contractual Commitments
Most asset finance agreements are non-cancellable for the full term. If your business circumstances change — for example, the equipment is no longer needed — you may still be obligated to make all remaining payments. Early termination charges can apply.
Ownership Restrictions (Leasing)
Under finance lease and operating lease arrangements, the finance company retains ownership of the asset. You cannot sell, modify, or dispose of the equipment without the lessor's consent. At the end of a finance lease, you typically do not automatically own the asset.
Depreciation Risk (Hire Purchase)
With hire purchase, you own the asset at the end of the term. If the asset has depreciated faster than expected, you bear the residual value risk. This is particularly relevant for technology assets and vehicles with high mileage.
Maintenance Obligations
Under most asset finance agreements (except fully maintained contract hire), you are responsible for maintaining the asset in good working condition. Failure to maintain the asset can constitute a breach of the agreement and may affect the residual value.
Excess Charges (Operating Lease/Contract Hire)
Operating leases and contract hire agreements typically include mileage or usage limits. Exceeding these limits results in excess charges at the end of the agreement, which can be substantial. Accurate forecasting of usage is essential.
Impact on Borrowing Capacity
Some finance lease and hire purchase agreements appear as liabilities on your balance sheet, which can affect your gearing ratios and potentially impact your ability to secure additional borrowing from banks and other lenders.
Personal Guarantees
For smaller businesses or those with limited trading history, the finance provider may require personal guarantees from directors. This means you could be personally liable for the outstanding balance if the business defaults on payments.
Mitigating the Disadvantages
Many of these disadvantages can be mitigated by choosing the right product for your specific needs. For example, if you want ownership, hire purchase eliminates lease-end uncertainty. If you want to avoid depreciation risk, an operating lease transfers that risk to the lessor. Aberdeen Corporate Finance advises on the optimal structure to minimise downsides while maximising benefits.
Important Notice: This information is for general guidance only. Specific terms vary by provider and agreement. Aberdeen Corporate Finance Limited is not regulated by the FCA.
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