Working capital loans help companies meet cash shortfalls and borrow money for daily expenses such as payroll or inventory purchases. Even profitable businesses can face liquidity issues, which is what working capital loans help reduce.
While working capital loans can help your company meet its needs, there are drawbacks to consider before relying too heavily on them.
What are working capital loans?
Working capital loan is a type of short-term business loan. They usually have quick applications and funding, helping businesses borrow money to meet immediate needs like paying rent or covering payroll. They also have shorter repayment terms, usually no more than a year or two.
Companies that do not have enough cash to pay for day-to-day operating costs can use a working capital loan to bridge the gap.
Types of Working Capital Loan
There are several different types of loans you can use for working capital, including term loans and business lines of credit. Each works slightly differently and is designed for different uses. Knowing which one is right for your situation can help you find the best loan.
|working capital loan type||Description|
|Term loan||Traditional loans offer a one-time advance and regular payments over the next weeks, months or years.|
|sba loan||Large loans insured by the Small Business Administration. Approval may take longer but the loan limit is very high.|
|lines of credit||Flexible credit lines let you withdraw money as many times as you need. You pay interest only on the current balance of the line of credit.|
|business credit card||Flexible credit lines designed for everyday purchases. No interest is charged if you pay the balance in full each month.|
|Invoice Financing / Factoring||Financing secured by the value of your unpaid invoices. When your customers pay invoices, you can be paid a percentage of the outstanding amount immediately with automatic payments.|
|merchant cash advance||Small, quick loans for buying inventory or for small immediate expenses. Payment is made by automatically sending a percentage of future sales to the lender.|
Pros of Working Capital Loan
Working capital loans have several benefits that make them a popular option for businesses in need of financial flexibility.
Because working capital loans are intended to pay for day-to-day operating expenses, lenders prioritize speed when it comes to funding approvals and timelines. This is especially true for online lenders who can often approve your application within minutes and put money into your company checking account the next day.
Collateral may not be required
Many working capital loans do not require collateral, which minimizes the risk on you as a borrower. It also simplifies the application process as you do not have to wait for the lender to evaluate your collateral and ensure that it is sufficient to secure the loan.
Eligibility Requirements Relaxed
Most lenders, especially online lenders, will have easy eligibility requirements for working capital loans. This helps make them more accessible to startups and business owners with bad credit – borrowers who typically struggle to get funding from traditional lenders like banks and credit unions.
Cons of working capital business loan
The best short term business loans can help when a business needs quick cash, but they have some important drawbacks to keep in mind.
small loan amount
The amount you can borrow using a quick working capital loan is usually much less than that of longer term loans or loans with more involved underwriting processes.
For example, many online lenders that specialize in fast working capital loans typically have limits of $100,000 or $250,000 for term loans and business lines of credit. This is well below the range banks offer of $500,000 and higher.
short repayment terms
Working capital loans are meant for short-term use, so lenders expect relatively quick repayment. Expect repayment terms of 18 months or less on many working capital loans, especially from lenders who work with business owners with fair or bad credit.
Sometimes, you can get a working capital loan which will give you two years or more to pay back the money. This includes lenders such as SMB Compass, which offers bridge loans for tenures of up to 36 months.
With most loans, it is expected that you will get a bill once a month and make a payment once every month. With working capital loans, that timeline can be accelerated. Many lenders ask for bi-monthly, weekly or daily payments depending on your loan details.
If you are already facing cash flow issues, the need to make frequent loan payments can exacerbate those problems. If you’re not careful, you could default on your loan or fall into a debt cycle.
Because working capital loans have quicker approval and less stringent requirements than other loans, many lenders charge higher rates and fees. Some high-risk alternative loans, such as invoice factoring, merchant cash advances and business lines open to business owners with bad credit, may use factor rates instead of interest rates. Factor rates are expressed as decimals, typically ranging from 1.1 to 1.6, and can be an expensive form of borrowing if you’re not careful.
Before accepting a loan that uses the factor rate, be sure to convert it to interest rates to compare it to other loans and better understand how expensive these loans are. Our guide to factor rates will show you how.
Working capital loans can help companies facing liquidity issues come up with the necessary funds to pay for their day-to-day operating costs. Their quick approval and easy eligibility requirements make them an easy way to borrow money. But relying on them too much can add up to costs and eventually your business’ financial woes.
If you decide a working capital loan is right for you, choose the right loan type and shop around to find the best deal.
Frequently Asked Questions
Does the SBA offer working capital loans?
Yes, the SBA offers working capital loans. You can use the organization’s CAPLINE credit line or SBA Express loan to meet working capital needs.
What credit score do you need for working capital?
Each lender sets its own requirements to qualify for the loan. Generally, online lenders have lower requirements than banks or credit unions and you may qualify with a score of 600 or even lower. However, a lower credit score would mean higher borrowing cost.
What are the benefits of working capital loan?
Working capital loans help meet short-term borrowing needs. They offer a number of benefits, including quicker approval and funding, simpler loan applications, and lower eligibility requirements compared to other types of business loans.