Types Of Working Capital Loans For Small Businesses

Whether you’re covering payroll during a slow season, stocking up on inventory, or managing day-to-day expenses, working capital loans can help you stay afloat.

With so many options out there, finding the best working capital loan for your business doesn’t have to be difficult. Understanding the different types of working capital loans and how they work can help you find the best fit for your needs.

Overview of working capital loans

Short-term loans

While term loans are often standard for business loans, if you’re in need of a working capital loan, you may want a short-term loan.

Like a term loan, a short-term loan offers a lump sum of cash that is paid off with regular payments over the term. Short-term loans have a much shorter repayment period of less than a year, and have an aggressive repayment period with monthly, weekly or even daily repayments.

Short-term loans often have lower loan amounts than standard loans, and come with higher interest rates. You may have an easier time qualifying for short-term loans, as they often have lower credit and revenue requirements, so long as you can keep up with the repayment schedule.

When a short-term business term loan makes sense

A business term loan makes the most sense when:

• You’re looking to make a single large purchase, like buying new equipment or bulk inventory, with a lump sum.
• You want a consistent repayment schedule.
• You can handle an aggressive repayment schedule.

Business lines of credit

A business line of credit gives your company longer-term access to a revolving pool of cash. You can draw money from the line of credit multiple times whenever you need the funds. As long as you stay below the credit limit, you can keep taking money from the line of credit, making it a great choice for companies that need flexibility. You’ll only pay interest on the outstanding balance of the credit line.

Lines of credit usually have variable interest rates, meaning the interest rate could rise over time. That makes them less predictable than fixed-rate loans. You can also expect higher interest rates on a line of credit than with a term loan.

When a business line of credit makes sense

A business line of credit makes the most sense when:

• You need flexible funding amounts, or are unsure of how much you need to borrow.
• You can manage a less-predictable repayment schedule.
• You don’t need a large loan amount.

SBA loans

The U.S. Small Business Administration’s lending program makes it easier for small businesses to access financing. It insures lenders against defaults, which lets those lenders offer larger loan amounts. SBA loans also have capped interest rates.

The requirements tend to differ from traditional loans as well – for example, in order to qualify for an SBA loan, you must have exhausted all other funding options.

Though some SBA loan programs have lengthy approval processes, they offer faster loans that work well as working capital loans.

SBA 7(a) loans

SBA 7(a) loans have loan amounts of up to $5 million and repayment terms of up to 10 years when used for working capital. It can take up to 90 days to receive funds, but the capped interest rates make them one of the most affordable options.

Some lenders like Lendio or Creditfy have relaxed eligibility requirements that can make them more accessible than the requirements found with banks and credit unions.

SBA 504 loans

SBA 504 loans are used for real asset purchases, such as real estate or equipment. They come with a limit fo $5 million, or $5.5 million if your business is classified as a manufacturer. While they can’t be used for payroll or other purchases, they can be useful if you need new or replacement equipment.

SBA Express

SBA Express loans are a type of SBA 7(a) loan. Unlike standard 7(a) loans, which have borrowing limits of up to $5 million and require approval from the SBA, Express loans are designed to be quick. They offer up to $500,000 and don’t require additional approval from the SBA. These loans can be secured or unsecured, with no collateral required for loans up to $50,000.

When SBA loans make sense

An SBA loan might make sense if:

• Your business can’t otherwise qualify for traditional loans
• You’re looking for a more affordable loan
• You can meet requirements and

Invoice financing/factoring

Invoice financing and factoring rely on the value of your unpaid invoices to help you secure financing.

With invoice financing, you borrow money against the value of your invoices in the form of a loan or line of credit. You then pay the lender back once you get paid for the invoice. Invoice factoring involves selling your invoices to a lender for a percentage of their value. Your customers then pay the lender directly.

With invoice factoring and invoice financing, you are able to access more working capital without waiting for your customers to pay their invoices. If you have a lot of invoices, you can potentially borrow larger amounts. It’s also easier than other types of credit to get approved for, as your invoices serve as collateral.

There are some downsides to consider. Invoice factoring or financing can be pricey. You’ll lose 5 percent or more of the value of your invoices. You also become even more reliant on your customers paying the bills. Depending on the terms of your financing or factoring agreement, you’ll be on the hook to pay back the debt even if your customers never pay you.

When invoice financing/factoring makes sense

Invoice financing or factoring makes sense when:

• You need fast cash and don’t otherwise qualify for other loan types.
• Your customers pay their invoices reliably.
• You don’t mind paying high fees.

Merchant cash advances

Merchant cash advances are designed for companies that need quick funds to buy inventory or cover immediate costs. What sets them apart is that the amount you can borrow is largely determined by how much your company makes in daily sales.

Payment of this loan happens automatically, with the lender taking a percentage of your company’s daily credit and debit card sales until the loan is paid off.

Because your future sales automatically go toward payment, these loans can be easier to get than other types of financing, especially if you can show a long history of credit and debit card sales. But costs can be quite high.

Merchant cash advances use factor rates rather than interest rates, and those factor rates may be as high as 1.50. That means that for every $1,000 you borrow, you have to pay back $1,500.

When a merchant cash advance makes sense

Merchant cash advances make sense when:

• The bulk of your transactions are through credit and debit card sales.
• You don’t have the credit score to qualify for other business loan types.
• You can handle paying a high factor rate.

Business credit cards

Business credit cards work much like consumer credit cards. You can use them to make everyday purchases and can keep using them to access funds until you hit your credit limit.

One big benefit of business credit cards is that you can avoid paying interest if you pay your balance in full monthly. You can also use business credit cards to build business credit. Some cards also offer rewards like cash back, points or airline miles, making them even more appealing.

The drawback of credit cards is that their limits are usually lower than term loans and some lines of credit.

Typically, rates for the best business credit cards won’t exceed 30 percent. That’s higher than some loans, especially term loans or lines of credit from banks, though it’s lower compared to the rates found with other types of loans, including merchant cash advances or online business loans for companies with bad credit, where effective rates can exceed 50 percent.

When a business credit card makes sense

A business credit card makes sense when:

• You want to establish and build business credit.
• You’re looking for additional perks, such as purchase protection, or want to take advantage of spending rewards.
• You’re looking for a lower funding amount or need flexible funding.

Bottom line

Working capital loans come in many forms, each offering different ways to help your company meet its short-term financial needs. Consider the working capital needs of your business to choose the right type of loan. For flexibility, you may want to opt for a business line of credit or a business credit card. For set expenses, your business may benefit more from a short-term loan or 7(a) loan.

No matter which type of loan your business needs, take the time to shop around for the best deal. The more research you do at the start of the process, the better off your business will be when covering its short-term expenses.

Frequently asked questions

• Are working capital loans a good idea?
  

  This will depend on your business situation, what you intend on using the loan for and how you plan on paying it back. When deciding on a loan, be sure that you understand the terms and that you can handle the repayment schedule. If you’re unsure about going into debt, you might want to use your cash reserves or look into getting a business grant.

• How much does it cost to borrow working capital?
  

  Working capital loan costs can vary significantly. Well-qualified borrowers getting a loan from a bank might pay about 7.3 percent interest. Companies with poor credit using merchant cash advances might pay factor rates of 1.50 or higher, which could be equivalent to interest rates of 80 percent or higher.

• What credit score do you need for working capital?
  

  Every lender is free to set its own requirements, but working capital loans usually have less strict requirements than other types of financing. It’s possible to find lenders willing to work with you if you have a credit score of 600 or even lower. Companies with low credit scores might need to offer collateral or a personal guarantee to qualify.