Pros and cons of working capital loans

Working capital loans help companies borrow money to cover cash shortfalls and pay for everyday expenses like payroll or inventory purchases. These loans are helpful because they offer quick access to funding and allow you to use the funding for nearly any purpose. And the best working capital loans can help your company make ends meet without imposing strict requirements to be eligible for the loan.

That said, working capital loans typically come with short repayment terms, like 24 months or less. You might also be stuck with a tight repayment schedule, such as daily or weekly payments. Consider all the pros and cons of working capital loans when comparing loan options to make sure you’re making the best decision for your business.

What are working capital loans?

A 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 such as paying the rent or covering payroll. They also tend to have short repayment terms, usually no more than a year or two.

Companies that don’t have enough cash on hand to pay for daily operating costs can use working capital loans to help make up the difference.

Types of working capital loans

There are many different types of loans that you can use for working capital, including term loans and business lines of credit. Each works a bit differently and is designed for different uses. Knowing which is right for your situation can help you find the best loan.

Pros of working capital loans

Working capital loans have many advantages that make them a popular choice for businesses needing financial flexibility.

Fast funding

Because working capital loans are intended for paying day-to-day operating expenses, lenders prioritize speed when it comes to approval and funding timelines. This is especially true of online lenders, who can often approve your application within minutes and put money in your company’s checking account the next day.

May not require collateral

Some working capital loans don’t require collateral, reducing the risk you face as a borrower. With secured loans, the lender can seize assets used to back the loan if you fail to make payments. With an unsecured loan, you won’t risk immediately losing assets or control over your business, though the lender can still demand repayment. You may also choose a working capital loan over selling equity in your business, helping you to retain ownership.

Not using collateral also makes the application process easier because you don’t have to wait for the lender to appraise your collateral and ensure it’s worth enough to secure the loan.

Funds can be used for any purpose

Working capital loans are designed to simply boost the working capital needed to cover business expenses or expansions. But unlike other loans like equipment loans that are designed for a specific purpose, you can use working capital loans for nearly any purpose.

Some common uses for working capital loans include:

• Covering day-to-day operational expenses
• Purchasing materials or inventory
• Purchasing assets that boost business growth
• Expanding your business or business acquisition

Relaxed eligibility requirements

Most lenders, especially online lenders, will have relaxed eligibility requirements for these short-term loans. It’s possible for business owners to find working capital loans for startups or bad credit.

Cons of working capital business loans

The best short-term business loans can help when a business needs quick cash, but they have some important drawbacks to keep in mind.

Smaller loan amounts

The amount you can borrow using a quick working capital loan is typically much smaller than with longer-term loans or loans with more involved underwriting processes.

For example, many online lenders specializing in fast working capital loans typically have limits of $100,000 or $250,000 for term loans and business lines of credit. This is much smaller than the limits of $500,000 and higher banks offer.

Short repayment terms

Working capital loans are intended for short-term use, so lenders expect to be paid back relatively quickly. Expect repayment terms of up to 24 months, though lenders that offer working capital loans for bad credit may have even shorter repayment periods.

Frequent payments

With most loans, the expectation is that you’ll get a bill once a month and have to make payments once every month. With working capital loans, that timeline can accelerate. Many lenders ask for bimonthly, weekly or even daily payments, depending on your loan details.

If you’re already facing cash flow issues, needing to make frequent debt payments can compound those problems. If you’re not careful, you could end up defaulting on your loan or falling into a cycle of debt.

Higher costs

Because working capital loans have quick approvals and less stringent requirements than other loans, many lenders charge higher rates and fees. Certain high-risk alternative loans open to business owners with poor credit, like invoice factoring, merchant cash advances and some bad credit business lines of credit, may use factor rates rather than interest rates. Factor rates are expressed as decimals, typically ranging from 1.10 to 1.60, and can be a costly form of borrowing if you aren’t careful.

Bottom line

Working capital loans can help companies facing liquidity issues come up with the funds they need to pay their daily operating costs. Their quick approvals and easy eligibility requirements make them an easy way to borrow money. But relying on them too much can balloon costs and ultimately exacerbate your business’s financial woes.

Consider whether the pros of working capital loans, like lenient eligibility requirements and fast funding, outweigh the cons, like high interest rates, helping you make the best decision in getting a small business loan.

Frequently asked questions

• Does the SBA offer working capital loans?

  Yes, many types of SBA loans can be used for working capital. You can use the organization’s SBA 7(a) loan, CAPLine lines of credit, Community Advantage or SBA Express loans to cover working capital needs.

• What credit score do you need for working capital?

  Each lender sets its own requirements to qualify for a loan. Typically, online lenders have lower requirements than banks or credit unions, and you can qualify with a credit score of 500 or even lower. A low credit score, however, will mean high borrowing costs.

• What are the benefits of a working capital loan?

  Working capital loans help cover short-term borrowing needs. They offer many benefits, including quick approvals and funding, simple loan applications and lower eligibility requirements, than other types of business loans.