Working Capital Loans are loans that are used to fund the everyday operations of a business. The purpose of these loans are not used to purchase major items like “long-term assets” or even investments, instead they are used exclusively for operational needs such as paying the rent, any debt, and payroll. They are considered “corporate debt borrowings”.
Working capital loans are accessible in many forms. Some of them include: a term loan, a business line of credit, business credit cards that allow business owners to earn rewards, and invoice financing which is a type of short-term borrowing based on unpaid invoices.
Of course getting approved for a working capital loan has its immediate benefits, but it also has its drawbacks that need to be mentioned. Let’s explore them below.
The Pros
- You can keep yourself afloat during lean times.
The obvious reason why securing a working capital loan is beneficial is that you get an immediate influx of desperately needed cash to cover any leakage that has happened during your daily operational expenditures.
- You still own your business.
Although it’s exciting to secure an angel investor to help fund your vision, it always comes at a great price. This usually involves their taking on a great percentage of ownership in your company. However, if you just borrow from a bank, your only obligation is to make your payments on time, until the end of the loan. Once that is satisfied, you are still in full possession of your company along with the decision-making power.
- They are surprisingly fast.
Applying for a personal or a traditional business loan means the process will be tedious, long, and daunting. You are restricted in how you can use the funds. Excessive amounts of paperwork, putting up collateral, “personally guaranteeing” the loan, then there’s the long wait. With a working capital loan, you have immediate access to your funds in as little as a week after your application has been accepted.
The Cons
- Interest rates are higher.
Most working capital loans are unsecured and have higher interest rates than secured business loans. You will pay more over the life of the loan than if you would have been paying off a secured loan in the same amount. However, only businesses with high credit ratings can qualify for unsecured loans.
- It can negatively impact your credit score.
Taking out multiple loans could spell trouble for your credit rating. Every loan gets documented in your credit rating which flags you as a higher risk to lenders. Once you are labeled as a risk, your interest rate will go up. If you are slow to pay or don’t pay, this too can negatively affect your credit rating. It’s best to be digilant, pay on time, and pay off completely.
- It’s only for a short time.
Although your business will get a much-needed boost of capital during lean times, it is obviously just a band-aid solution. It will not completely resolve your ongoing need for capital. It will only address short, time-specific gaps and not cover any long-term goals. Long-term goals will require higher investments.
Weigh Your Options
Working capital loans are a great option for cash-strapped business owners who are getting started or have been running their business for a good period of time. There will always be a time when funds are simply not available to move forward. However, it is always important to weigh the pros against the cons to make an informed decision.