What are the different types of asset finance?

Asset finance is a crucial funding tool utilized by businesses across the UK, ranging from sole traders needing a commercial vehicle to large corporations acquiring multi-million-pound factory equipment. It enables businesses to grow, upgrade technology, and maintain competitiveness without depleting crucial working capital.

Understanding What are the Different Types of Asset Finance Available to UK Businesses?

Asset finance is a broad term covering financial solutions specifically designed for the acquisition or retention of physical business assets. Unlike traditional loans where a lump sum is borrowed and repaid, asset finance structures the funding around the value and lifespan of the asset itself. The asset typically serves as collateral for the funding agreement, making it a form of secured finance.

For UK businesses seeking to understand their options, the various products available can generally be categorized based on whether the primary goal is eventual ownership (Hire Purchase) or simply the right to use the asset for a specified period (Leasing).

The Fundamental Benefits of Using Asset Finance

Businesses often choose asset finance over outright purchasing or unsecured loans for several practical reasons:

• Capital Preservation: It allows businesses to acquire high-value assets immediately without tying up large amounts of capital that could be used for day-to-day operations or stock.
• Fixed Payments: Most asset finance agreements involve fixed monthly payments, making budgeting and cash flow management predictable.
• Tax Efficiency: Depending on the structure (leasing vs. purchase), there can be significant tax advantages, such as claiming Capital Allowances or deducting rental payments as a business expense.
• Security: Since the asset itself acts as security, asset finance can often be easier to obtain than unsecured business loans, especially for newer companies.

The application process for asset finance involves thorough due diligence on both the business’s financial health and the directors’ creditworthiness. While the main focus is usually on company accounts and asset valuation, the financial history of the individuals running the business can play a role, particularly for smaller limited companies or sole traders. Get your free credit search here. It’s free for 30 days and costs £14.99 per month thereafter if you don’t cancel it. You can cancel at anytime. (Ad)

Type 1: Hire Purchase (HP) – Ownership as the Goal

Hire Purchase (HP) is arguably the most straightforward type of asset finance for businesses that intend to eventually own the asset outright. HP functions much like an installment loan, but crucially, the customer does not legally own the asset until the final payment is made.

How Hire Purchase Works

In a standard HP agreement, the financier purchases the equipment or vehicle on behalf of the business. The business then makes regular repayments over an agreed term (typically 1 to 5 years). These repayments cover the capital cost of the asset plus interest and charges.

Key features of HP include:

• Initial Deposit: Typically required, often 10% of the asset value, though 0% deposit options may sometimes be available.
• Ownership Transfer: Ownership legally transfers to the business upon payment of the final installment, which often includes a small ‘Option to Purchase’ fee.
• Balance Sheet Treatment: For accounting purposes, the asset is usually treated as if it were owned by the business from the start, appearing on the balance sheet.
• Tax Treatment: The business can generally claim Capital Allowances (a form of tax relief on investment) against the purchase price of the asset, though interest repayments are often deductible as a business expense.

HP is highly suitable for assets expected to have a long useful life and where the business needs full control, such as heavy machinery, printing presses, or specialized manufacturing equipment.

Type 2: Finance Leasing (Capital Lease) – Long-Term Usage

Finance leasing, sometimes called a Capital Lease, is a contractual agreement that provides the business with the use of the asset for almost all of its economic life. Unlike Hire Purchase, the business generally does not gain legal ownership at the end of the term, though they benefit from the majority of the risk and rewards associated with ownership.

Understanding the Mechanics of a Finance Lease

Under a finance lease, the rental payments made over the primary period often cover the majority (sometimes 90% or more) of the asset’s original purchase price.

• Ownership: Legal ownership of the asset remains with the leasing company (lessor).
• Residual Risk: The user (lessee) often carries the financial risk associated with the asset’s depreciation.
• End of Term: Options typically include returning the asset, entering a secondary rental period (often at a significantly reduced rate), or sometimes purchasing the asset for a nominal fee (though specific tax and legal rules apply here to avoid classifying it as HP).

In the UK, Financial Reporting Standards (FRS) often dictate that assets acquired under a Finance Lease must be recorded on the lessee’s balance sheet, similar to a purchased asset, reflecting the substance of the transaction over the legal form.

Type 3: Operating Leasing (Contract Hire) – Flexibility and Off-Balance Sheet

Operating leasing, frequently used for vehicles (known as Contract Hire) and fast-depreciating technology, focuses purely on the use of the asset for a shorter, finite period. The fundamental difference from a Finance Lease is that the leasing company retains the significant risks associated with the asset, particularly its residual value.

Key Features of Operating Leases

Operating leases are designed for maximum flexibility and are often preferred when businesses need to frequently upgrade their equipment, such as IT hardware, company car fleets, or construction equipment used for specific projects.

• Shorter Term: The term is usually significantly shorter than the asset’s total economic life (e.g., 2 or 3 years for a car).
• Residual Risk: The leasing company forecasts the residual value (what the asset will be worth at the end of the lease) and structures the payments accordingly.
• Maintenance and Service: Operating leases often include maintenance packages, insurance, and servicing, bundling costs into one monthly payment.
• Balance Sheet Treatment: Historically, a major draw of operating leases was that they could be kept ‘off-balance sheet,’ treating the payments purely as an operating expense. However, changes in accounting standards (like IFRS 16) mean that most long-term leases now need to be recognised on the balance sheet.
• Tax Efficiency: Lease rental payments are generally 100% deductible as a business expense, making this option highly tax-efficient, particularly for VAT-registered companies (though VAT rules vary based on the asset type, such as cars).

The flexibility offered by an Operating Lease means that at the end of the term, the business simply returns the asset to the lessor, avoiding the hassle and uncertainty of disposal.

Type 4: Asset Refinance and Sale and Leaseback

While the first three types focus on new asset acquisition, asset refinance options are crucial for companies looking to unlock capital tied up in existing owned assets.

Asset Refinance

Asset Refinance involves taking out a loan secured against an asset the business already owns outright. This allows the business to raise working capital or repay existing, higher-interest debt, using the value of the machinery or equipment as collateral.

Sale and Leaseback

Sale and Leaseback is a specific type of refinancing where a business sells an owned asset (like a piece of factory machinery) to a finance company for a lump sum. Immediately upon sale, the finance company leases the asset back to the original owner via a Finance Lease or Hire Purchase agreement.

This process achieves two immediate goals:

• It injects immediate capital (the sale price) into the business.
• It allows the business uninterrupted use of the essential asset, now subject to regular rental payments.

This is often used by established businesses seeking rapid capital injection for expansion, acquisitions, or to manage cash flow difficulties.

Comparing the Core Asset Finance Options

The decision between HP and the various leasing structures hinges on control, ownership, and tax strategy. Here is a brief comparison of how the two primary models differ:

Hire Purchase vs. Operating Lease

Hire Purchase (HP):

• Ownership: Intended at the end of the term.
• Risk: Borne by the user (depreciation risk).
• Accounting: On-balance sheet liability and asset.
• Tax Benefit: Capital Allowances are claimed on the asset value.

Operating Lease:

• Ownership: Retained by the lender.
• Risk: Borne mostly by the lender (residual value risk).
• Accounting: Rental payments are operating expenses (though accounting standards are evolving).
• Tax Benefit: Lease rentals are fully deductible as an operating cost.

Businesses must carefully consider the total cost of borrowing versus the overall tax advantages. UK government resources, such as those provided by HMRC, offer detailed guidance on how different types of finance and purchases qualify for tax relief and Capital Allowances, which is vital for compliance. You can find comprehensive information on tax deductions for business expenses and investments on the GOV.UK website.

Understanding Risk and Commitment

While asset finance offers significant advantages, businesses must approach these long-term commitments responsibly. All asset finance agreements represent debt, and failure to meet the agreed repayment schedule can have serious consequences.

Financial and Operational Risks

• Contract Commitment: Asset finance agreements are typically non-cancellable. Exiting an agreement early often incurs substantial termination fees or requires paying the remaining balance.
• Asset Obsolescence: If the asset is technological and tied to a long-term HP or Finance Lease agreement, there is a risk that the equipment will become obsolete before the contract ends, leaving the business paying for outdated machinery.
• Default Consequences: Since the asset is the collateral, if the business defaults on payments, the finance provider has the right to repossess the asset. This could severely impact business operations, especially if the asset is critical production machinery.

Before committing to any asset finance product, robust financial planning and forecasting are essential to ensure the repayments are sustainable throughout the duration of the agreement.

People also asked

Is asset finance secured or unsecured?

Asset finance is almost always a form of secured finance. The asset being financed (e.g., the vehicle, machinery, or equipment) serves as the primary security for the loan or agreement, meaning the finance provider can repossess the asset if the terms of the agreement are breached, particularly through payment default.

What is the difference between an asset finance broker and a direct lender?

A direct lender (the funder) provides the capital themselves. A broker acts as an intermediary, using their knowledge of the market to match the business seeking finance with the most suitable lender and the best terms available, often accessing a wider range of specialist products.

Can asset finance be used for intangible assets?

Generally, no. Asset finance, by definition, is designed for tangible, physical assets that can be valued and repossessed if necessary (hard assets like vehicles and machinery, or soft assets like IT equipment). Intangible assets like patents, goodwill, or intellectual property typically require different forms of funding, such as working capital loans or equity investment.

How does the depreciation of the asset affect my finance choice?

If the asset depreciates quickly (e.g., technology), an Operating Lease may be preferable, as the leasing company shoulders the residual value risk, allowing the business to upgrade sooner. If the asset holds value well and the business wants to benefit from long-term value, Hire Purchase is often the better choice, allowing the business to benefit from the tax relief and eventual ownership.

What happens at the end of a Finance Lease agreement?

At the end of the primary period of a Finance Lease, the business typically has a few options, which must be clearly defined in the contract: it can return the asset, enter a secondary rental period (often called a ‘peppercorn’ or nominal rental period), or, less commonly but sometimes possible, purchase the asset for a fixed final amount.

Conclusion: Choosing the Right Asset Finance Solution

Selecting the right type of asset finance depends entirely on the business’s goals, operational needs, and long-term financial strategy. If long-term ownership and the ability to claim Capital Allowances are paramount, Hire Purchase is generally the favoured method. If flexibility, frequent upgrades, and maximising tax deductibility of rentals are the priority, an Operating Lease is often the best fit.

Businesses considering substantial asset acquisition should consult with both an authorised financial adviser and a qualified accountant to fully understand the tax and balance sheet implications of each option before committing to an agreement.