What is a Working Capital Loan?

During the pandemic, small business funding has been a crucial support for many entrepreneurs. But even in normal times, getting a small business loan can be a smart move to boost your business. Whether it’s hiring more staff, advertising, or stocking up on inventory, financing can help you grow.

However, with so many loan options out there, it can be overwhelming to pick the right one. One option that’s particularly flexible and useful for small businesses is a working capital loan. These loans are handy for short-term needs like buying inventory, paying bills, or covering wages.

Let’s take a closer look at how working capital plays a role in small businesses and why a working capital loan might be just what you need to keep your business running smoothly.

Understanding Working Capital

Working capital is the money a business has available to handle its daily expenses, such as paying employees, covering utility bills, purchasing supplies, and paying rent. To find your working capital, subtract what you owe (liabilities) from what you own (assets). If the result is negative or insufficient, you might consider applying for a working capital loan to bridge the gap.

What are the Benefits of Working Capital Loans?

Working capital loans are like short-term financial boosts designed to help with immediate business needs. This could be anything from paying employees, buying supplies, restocking inventory, to hiring more staff. The beauty of these loans is that they’re pretty versatile, so whatever your business challenge is, chances are a working capital loan can help out.

1. No Need for Collateral
   Imagine you’re in a pinch and need money to keep your business afloat. With working capital loans, you don’t have to worry about putting up any assets as collateral.
   This means you don’t risk losing your valuable property or equipment if you’re unable to repay the loan. It’s a safety net that gives you financial support without the added stress of potential loss.

1. Flexible Spending
   Think of working capital loans as your financial Swiss Army knife. You can use the funds for a wide range of business expenses, from paying bills and salaries to stocking up on inventory or even launching a new marketing campaign.
   This flexibility allows you to adapt quickly to changing circumstances and seize opportunities as they arise. It’s like having a financial toolbox at your disposal to tackle whatever challenges come your way.

1. Keep Ownership
   Maintaining control and ownership of your business is crucial for many entrepreneurs. With working capital loans, you don’t have to give up any shares or equity in your company to secure financing.
   You retain full autonomy to make decisions and steer your business in the direction you want without outside interference. It’s empowering to know that you can get the financial help you need without sacrificing your vision or control.

1. Quick and Simple Application
   Time is of the essence when you’re facing cash flow issues or urgent expenses. Working capital loans often offer a streamlined application process, allowing you to access funds quickly and with minimal hassle.
   Instead of jumping through hoops or waiting weeks for approval, you can get the money you need within days, if not hours. This speedy turnaround can be a game-changer, providing much-needed relief and peace of mind during challenging times.

Downsides of Working Capital Loans

1. Credit Profile Dependency

Picture this: getting a loan is like asking a friend for help. But with working capital loans, your friend (the lender) wants to make sure you’re good at paying back what you borrow.

If your business doesn’t have a great track record of paying bills on time or managing money well (aka a less-than-ideal credit history), it might be harder to get a loan. You might not get the best deal, or you might need to look for other ways to borrow money.

1. Interest Costs
   Think of interest as a fee you pay for borrowing money. Working capital loans can be convenient, but sometimes, that convenience comes with a price tag. They might have higher interest rates compared to other types of loans.
   So, while you get the money quickly, you’ll end up paying more in the long run. It’s important to think about how much you’ll have to pay back and how it’ll affect your profits.

1. Short Repayment Terms
   Imagine borrowing money and having to pay it back really quickly, like trying to finish your homework before recess ends. That’s what it’s like with working capital loans. You usually have to pay back the money within a short time, like 6 to 18 months.
   This means you’ll have to make payments often and for a short period, which can be tough on your cash flow. It’s like having to give back what you borrowed before you’ve had enough time to make more money.

1. Limited Loan Amounts
   Sometimes, the amount of money you can borrow with a working capital loan isn’t enough to cover everything you need. It’s like trying to fill a bucket with water, but the bucket is too small.
   Depending on how well your business is doing financially and what the lender says, you might not get as much money as you hoped for. This can be a problem if you need more money for bigger projects or long-term investments.
   Before you decide to get a working capital loan, take a good look at the advantages and disadvantages. Think about how they match up with what your business needs and can handle financially.

Also, keep in mind that there isn’t just one kind of working capital loan. There are different types out there, and each one suits different situations. So, it’s crucial to pick the one that fits your business needs perfectly. Let’s dive into some of the most common types of working capital loans.

Term Loan

A term loan is like borrowing a chunk of money and paying it back bit by bit, along with some extra cash called interest. It’s similar to how you might take out a loan to buy a house or a car. Here’s how it works:

• Getting the Money
  Just like when you get a big allowance all at once, with a term loan, you get a lump sum of money right from the start.

• Paying it Back
  But here’s the catch: you have to pay back that money over a set period, which is called the term. Think of it like paying back a big debt over time. You’ll make regular payments, which could be every day or every month until the loan is fully paid off.

• Short-Term Focus
  Since working capital loans are meant for short-term needs, term loans also have short repayment periods. This means you’ll need to pay back the money relatively quickly, usually within 6 to 18 months. It’s like finishing your homework before the end of the school year.

• Qualifying for the Loan
  To qualify for a short-term loan, you usually need to have been in business for a couple of years already. Lenders want to see that you have a good track record of running your business and making money. They’re more likely to lend to businesses with steady cash flow because they want to be sure you can make those regular payments on time.

• Secured vs. Unsecured Loans
  Depending on your credit and the lender’s policies, you might get either a secured or unsecured loan. If your credit is excellent and the lender trusts you not to skip out on payments, you might get an unsecured loan.

That means you don’t have to put up any collateral, like your business or inventory, to get the money. But if the lender sees more risk, they might ask for collateral to secure the loan. This could be something valuable that you own, like equipment or property. If you can’t pay back the loan, the lender can take that collateral as payment instead.

Line of Credit

A line of credit is like having a safety net for your business finances. Here’s how it works:

• Access to Cash as You Need It
  Think of a line of credit as a pool of money ready and waiting for you whenever you need it. It’s like having money tucked away for a rainy day. You don’t have to take out the full amount all at once. Instead, you can dip into it whenever you have expenses to cover.

• Similar to a Credit Card
  If you’ve used a credit card before, you’ll understand the basics of a line of credit. It’s like having a credit card but with a bigger spending limit and usually lower interest rates. Just like with a credit card, you’re approved for a certain amount of money you can borrow whenever you need it.

• Qualifying for a Line of Credit
  Whether you can get a line of credit and how much you can borrow often depends on things like your business’s credit history and how much money you make. Lenders want to be sure you can pay back what you borrow, so they’ll look at your financial history to decide how much to lend you.

• Interest and Repayment
  Here’s the good part: you only pay interest on the money you use from your line of credit, not on the full amount available to you. It’s like only paying rent for the room you’re staying in, not the whole house. And when you use the money, you start paying it back immediately. But keep in mind, there might be a small fee just for having the line of credit, sort of like a membership fee.

• Revolving vs. Non-Revolving
  With a revolving line of credit, you can borrow, repay, and borrow again, kind of like a never-ending cycle. As long as you keep repaying what you’ve borrowed, you can keep dipping into the pool of money whenever you need it. But with a non-revolving line of credit, once you pay back what you’ve borrowed, that’s it. You can’t borrow more money until you apply for a new line of credit.

Merchant Cash Advances

Merchant cash advances (MCAs) are a type of loan where you get money now by promising a portion of your future sales. Instead of paying fixed monthly amounts, you pay back the loan through a percentage of your daily sales. This means when sales are high, your payments are higher, and when sales are low, your payments are lower.

When you get an MCA, the provider gives you a lump sum of money upfront, and then you pay it back gradually with a portion of your daily sales. The approval is mainly based on your sales, not your credit score. This can be useful for businesses that are just starting out and don’t have a strong credit history yet.

There are two important terms to understand with MCAs: the factor rate and the holdback rate. The factor rate determines the total cost of the loan, and the holdback rate is the percentage of your sales that goes towards paying back the loan each day.

The cost of MCAs can vary a lot, which can make it challenging to budget. Normally, when your sales go up, you have more money to invest in your business. But with an MCA, higher sales mean higher repayment amounts, which can be tough to manage in your budget.

Despite the challenges, MCAs can be a lifeline for businesses in need of quick cash. They offer flexibility and can help businesses get through tough times when they’re short on funds.

Where Can Small Business Owners Get Money to Keep Their Business Running Smoothly?

Here are some places to consider:

1. Traditional Banks: Big banks can give loans, but they often need lots of paperwork and take a while to decide.
2. Online Lenders: Websites like peer-to-peer lending platforms offer loans, too. They’re faster and more flexible but might charge higher interest rates.
3. Credit Unions: These are community banks that sometimes have good loan deals for their members.
4. SBA Loans: The Small Business Administration gives loans with good terms, but the process can be slow and paperwork-heavy.
5. Online Business Lenders: Some websites specialize in giving quick loans to small businesses.
6. Invoice Financing: If you have unpaid bills from customers, you can borrow money based on those bills.
7. Equipment Financing: You can get a loan to buy equipment and pay it off over time.
8. Business Credit Cards: Using a business credit card can be easy for small expenses, but watch out for high interest rates.
9. Microlenders: These are organizations that lend small amounts of money, often to businesses in specific areas or communities.

Before deciding on your loan source, it’s crucial to carefully review the terms, interest rates, and repayment terms. Seek guidance from a financial advisor to ensure you make an informed decision.

Additionally, consider exploring GoKapital, a trusted private lender offering tailored business loans and real estate financing solutions to meet your specific needs. Their expertise and personalized approach can help you secure the funding necessary for your business growth and success.