Up until about ten years ago, if a business owner needed money to expand their company or obtain working capital, their options were very limited. It was either apply for a business loan with a bank, or fund their business using personal resources, such as a second mortgage on the house.
After the latest financial crisis began to blow over, and business owners began to look towards making their business profitable again, a serious funding problem became evident. Banks were no longer as eager to help business owners, and poor credit ratings resulting from the recession limited the personal funding choices.
Seeing that there was an increased need for funding options for businesses, a number of alternative options were created by lenders. These options focus more on the business and its vision and profitability rather than on the owner’s credit score, affording him or her the opportunity to build their business without having to go through the long drawn out bank loan process only to be rejected in the end.
What is a Working Capital Business Loan?
A working capital business loan refers specifically to a loan product that is meant to help with the day to day expenses of running a business. These are not necessarily meant for buying a new retail location or large piece of machinery. Rather, they are typically used to help with paying overhead costs, keeping up with payroll and ensuring a steady flow of materials needed to continue with production.
Many small businesses have the money to keep up with daily costs, but it is tied up in their inventory or unpaid invoices. Getting working capital business loans helps to liquidate that money in a matter of days, so that the business can continue to grow and prosper. Some opponents to alternative lending products believe that this is a temporary fix for a business that could turn into a permanent problem.
The Supposed Risk in Getting Working Capital Business Loans
Alternative lenders look beyond a business owner’s credit score and consider the stability of the business by looking at factors like its daily transactions, revenue and growth potential. This gives a business owner who has flawed personal credit the chance to still build their business with the help of a loan.
What the opponents believe is that this method of lending can lead to a cycle of dependency, where the business is forever reliant on loans and lines of credit in order to stay afloat. Getting working capital business loans with poor credit poses a higher risk to the lender and can mean a higher interest rate than what a bank would offer. This, coupled with the shorter terms of working capital loans offered by alternative lenders, could possibly create more of a burden on the business, as they struggle to pay off the new debt.
Avoiding that Risk When Getting Working Capital Business Loans
Even large successful businesses rely on getting working capital business loans to help cover costs when their financial assets are physical items or unpaid invoices, and not the cash that they need. There is always going to be a cost to the business for taking advantage of this type of funding, but the cost is much higher if you are unable to take care of your daily business needs.
When looking into the various options for getting working capital business loans, make sure that you completely understand the terms and rates that accompany them. Not all options are the right fit for every business type. What you should try and do is find a working capital business loan that is utilizing the non-liquid assets that you already have. This ensures that you are not actually taking on a new debt, but rather using money that should be yours anyway. A good example of this is factoring.
What is Factoring?
Not all of your business’ sales are going to be paid the moment the product is delivered or the service is completed. If unpaid invoices are hurting your cash flow, then factoring is worth considering when thinking about getting working capital business loans.
Rather than taking on a whole new loan debt, you “sell” those unpaid invoices to an alternative lender. This essentially gives you the cash you would have if the bills were paid on time, minus a fee for the service. So long as this fee does not exceed your profit margin on the invoices, you are not losing any of your business equity, just a percentage of your profit.
Since you are not putting your business into further debt with this type of alternative loan, there is no reason to believe that your business will become dependent on them in order to survive. In fact, you may find that the convenience of having a third party handle your unpaid accounts receivable saves you time and ultimately money.
Getting Working Capital Business Loans Based on Future Earnings
Where factoring uses funds already owed to you to provide you with the working capital your business needs, a merchant cash advance does the complete opposite. This type of alternative lending option looks at the likelihood of future sales, and takes its payments directly from them.
This is more of a cash advance than a loan, as there is no written contract defining terms for when the money lent must be paid back and for how much. Instead, you and the merchant reach an agreement as to the percentage of your credit card sales they will deduct daily towards repaying the advance. A fee is added to your balance, and becomes a part of the money that you must pay back. The business owner is actually “selling” is future revenues at a cost so he/she can use those future revenues today. The lender or “funder” is called the “purchaser” in this transaction. There is no debt as this is not a loan, but as the business owner you are responsible to repay the funder as they paid for those future revenues. There are no collateral requirements at all which can make this an enticing option.
Take into consideration the same factors you would for factoring before committing to a merchant cash advance. Is the amount you must pay as a fee greater than your profit margin? Also, will deduction in revenue from your credit card sales make you unable to meet your business needs? If you are able to work out terms where neither of those points are an issue, then you are not creating a cycle of dependency by using this alternative loan solution. Merchant Cash Advances can be paid via your daily credit card receivables or as a daily payment directly from your business account. The latter is referred to as a revenue based business advance or revenue based working capital advance. Either method is still considered a “purchase” of future revenues and is not a loan.
Getting working capital business loans does not have to lead to a bad habit. Many of the available options are just helping you use money that would have been yours anyway so that your business can achieve a level of self-sufficiency. So long as you study the terms carefully and ensure that your business goals and profits are not being impacted, a working capital business loan from an alternative lender will do exactly what it is meant to, provide you with the money you need today, in order to ensure that you are still in business tomorrow.