Pros and cons of working capital loans

Working capital loans help companies borrow money to cover cash shortfalls and pay for everyday expenses like payroll or inventory purchases. The best working capital loans can help your company make ends meet without imposing strict requirements to be eligible for the loan.

That said, working capital loans typically come with short repayment terms, like 24 months or less. You might also be stuck with a tight repayment schedule, such as daily or weekly payments. Consider all the pros and cons of working capital loans when comparing loan options to make sure you’re making the best decision for your business.

Pros and cons at a glance

Pros

• Fast funding.
• May not require collateral.
• Flexible uses.
• Relaxed eligibility requirements.

Cons

• Short repayment terms.
• Frequent payments.
• Higher costs.

Pros of working capital loans

Working capital loans have many advantages that make them a popular choice for businesses needing financial flexibility. There are many types of working capital loans, so pros may vary based on what kind you choose.

Fast funding

Because working capital loans are intended for paying day-to-day operating expenses, lenders prioritize speed when it comes to approval and funding timelines. This is especially true of online lenders, who can often approve your application within minutes and put money in your company’s checking account the next day.

May not require collateral

Some working capital loans don’t require collateral, which eliminates the risk of losing your big assets, and also helps speed up the funding process because you don’t have to wait for an appraisal.  

Flexible uses

Working capital loans are designed to boost the working capital needed to cover business expenses or expansions, which means you can use them for nearly any purpose.

Some common uses for working capital loans include:

• Covering day-to-day operational expenses.
• Purchasing materials or inventory.
• Purchasing assets that boost business growth.
• Expanding your business or business acquisition. 

Relaxed eligibility requirements

Most lenders, especially online lenders, will have relaxed eligibility requirements for short-term working capital loans. It’s possible for business owners to find working capital loans for startups or bad credit.

Cons of working capital business loans

The best short-term business loans can help when a business needs quick cash, but they come with some important drawbacks to keep in mind.

Short repayment terms

Working capital loans are intended for short-term use, so lenders expect to be paid back relatively quickly. Expect repayment terms no longer than 24 months. Lenders that offer working capital loans for bad credit may have even shorter repayment periods.

Frequent payments

Due to shorter repayment terms, many lenders ask for bimonthly, weekly or even daily payments for working capital loans, which can cut into your business’s cash flow. Make sure you can afford the payments and payment frequency before you take on a working capital loan. If you’re not careful, you could end up defaulting on your loan or falling into a cycle of debt.

Higher costs

Because working capital loans have quick approvals and less stringent requirements than other loans, you will likely encounter higher rates and fees than you would with a traditional loan. This adds to the total cost of the loan, and can increase your payment amount. Some lenders may charge factor rates instead of interest rates, which typically convert to higher APRs and can make it difficult to compare options. 

Bottom line

Working capital loans can help companies facing liquidity issues come up with the funds they need to pay their daily operating costs. Their quick approvals and easy eligibility requirements make them an easy way to borrow money. But relying on them too much can balloon costs and ultimately exacerbate your business’s financial woes.

Consider whether the pros of working capital loans, like lenient eligibility requirements and fast funding, outweigh the cons, like high interest rates, helping you make the best decision in getting a small business loan.

Frequently asked questions

• Does the SBA offer working capital loans?

• What credit score do you need for working capital?

• What are the benefits of a working capital loan?