6 Types of Working Capital Loans Ideal for Small Businesses
Small business owners often need to find working capital for their companies. Whether it’s to pay bills, make payroll, buy inventory, purchase equipment or invest in future growth, businesses need a steady supply of working capital to manage their cash flow and capitalize on opportunities as they arise.
Here are a few of the most common varieties of working capital loans and how they can help your business:
Small Business Loan: The traditional small business bank loan is often viewed as a typical option for business owners to get working capital. However, especially in recent years, many small business owners have found it more difficult to get access to small business loans from traditional banks, particularly if the business owners do not have perfect credit or a long track record of being in business. Banks also are often reluctant to lend the smaller loan amounts that are typically needed by small business owners, preferring instead to issue larger business loans.
Credit Cards: Many small business owners borrow money for their business by using personal or business credit cards. Credit cards are a type of revolving credit account, which means that they can be used in a flexible way – you can borrow as much or as little money as you need, and then pay off as much or as little as you can afford to repay each month (as long as you make your minimum payments). One drawback of credit cards is that they often have credit limits that are too small to effectively fund big business needs – and their interest rates often make this form of borrowing more expensive than other working capital loans.
Small Business Line of Credit: With a small business line of credit, your business gets authorized in advance to be able to borrow a certain amount of money up to a certain credit limit or maximum loan that the lender will allow you to borrow. A line of credit works in the same way as a credit card – you get approved in advance for the amount that you are allowed to borrow, and then you can borrow money as needed, up to that maximum credit limit.
Home Equity Loans: Some small business owners can borrow money to help their business by tapping into a home equity loan or by borrowing against the value of real estate owned by the business. Interest rates for these loans are often lower than other options, since the loan is secured by real estate. However, one drawback of this type of working capital loan is that the borrower is forced to risk losing a piece of property (or even the family home) in case of default on the loan. Think carefully before risking your home – there might be better options to get the cash that your business needs.
Accounts Receivable Financing: Accounts receivable financing, also known as “factoring,” is a method of getting working capital that involves trading your accounts receivable to a “factor” which then gives you immediate cash based on the expected value of your future sales (once your customers pay in full). Factoring is a valid option for getting cash, but it can be challenging to get the fullest value for your accounts receivable, unless your customers are big corporate clients with strong credit ratings.
Personal Loans/Equity Funding from Investors: Many small business owners turn to their personal networks of friends and family to borrow money or raise capital, especially when starting a new business. It might make sense to turn to your inner circle first when needing to raise money – after all, these are the people who know you best and who believe in you the most. But mixing friendship with business can be risky! What if your business fails or loses your friends’ investment? It might be better to borrow money from the open market and keep your most important personal relationships separate from your business life.
There are a variety of options for working capital loans, and they each have their unique costs and benefits. Before committing to a source of working capital, be sure to evaluate your options carefully and look at the big picture of what your business needs. Ideally, your working capital source should help your business be better off than it was before, with the right degree of flexibility and the right size to fit your business objectives.
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