There are four working capital loan types. All of these loan types can help businesses fill gaps in their financing, make up for seasonal variability in income and cover payroll expenses. The types are: term loans, lines of credit, SBA loans and invoice factoring.
A business term loan is a lump sum of money you borrow from a lender, and pay back at a fixed interval— with interest — over a set period of time. Many businesses choose term loans because they don’t want to dip into their capital reserves but would rather allow a lender to finance their capital use (projects and business capital needs) at a fair price. In most cases you’ll pay off the loan monthly, however other payment terms might be available on a case-by-case basis. For example, some lenders offer daily, weekly and bi-weekly repayment options in addition to monthly options. Repayment periods generally begin at 12 months and last up to 10 years.
Term loans typically include these features:
Term loans are best to use when your business needs to invest in a longer-term enhancement or business improvement, or simply for a use case that will not diminish in a short period of time. Additionally, when the expected return on investment (ROI) is greater than the cost of the loan, then the term loan can be a great choice. It's less desirable to use a term loan when you are in a temporary cash crunch as this could drag your business down.
A business line of credit is revolving credit, allowing you to carry a balance that accrues interest. Think of it in the same way as a Credit Card. If you don't use the line of credit, you don't have to make any payments. Once you draw from the credit line, as long as you make the minimum payment each month, you can either pay your balance in full or pay whatever you can afford and keep in mind that your unpaid balance will accrue interest.
Typical features of a business line of credit include:
Business lines of credit offer more flexibility compared to term loans since businesses obtain access to cash up to a credit limit, and only pay interest on the amount they have borrowed. Businesses can draw and repay the financing as often as they wish, provided they stay current on payments and stay at or below the credit limit.
An SBA loan is guaranteed by the U.S. Small Business Administration.
These loans are designed to assist small businesses begin, maintain and expand. There are several SBA loan programs created for a variety of purposes and applicants. Each program contains its own loan sizes, terms and rates.
The primary SBA loans for working capital debt are:
Invoice factoring allows small businesses to obtain cash fast without needing to be eligible for a traditional loan or dealing with a long application process.
Invoice factoring is a procedure where a business sells its invoices to a third-party factoring company at a cost for a portion of the unpaid balances, typically 85%-95% of the full value.
For example, if your business provides an invoice to a customer for $5,000 and if the customer has up to 60-days to pay the invoice, your business is stuck waiting to be paid. A factoring company will purchase that invoice from you for a certain amount, for example $4,850. The factoring company will pay you upfront so you don’t need to wait on the payment from your customer.
If a business has clients that haven’t paid their invoices yet, this type of working capital loan lets them convert the invoices quickly into working capital subtracted by any fees.
The factoring company purchases a portion of the company’s invoices for an upfront payment and then gets reimbursed when the company’s client pays it directly.
