Small business owners today have more options than ever to borrow working capital. While the increased number of options is great, it can be overwhelming to find out which one is best for your small business.
This article will walk you through five different ways to get working capital, including the pros and cons of each option and the approximate cost.
1. SBA Loans
What it’s best for: Long-term working capital investments.
Whom it’s best for: Business owners who have been operating for at least two years and have strong credit scores.
A loan backed by the Small Business Administration (SBA) is one of the cheapest sources of working capital. The SBA itself doesn’t make loans–it guarantees loans that are issued by banks. The guarantee lowers the risk of the loan for banks, which allows them to give favorable terms to borrowers.
With interest rates currently averaging around 6 to 8 percent, you will be hard pressed to find a more economical way to borrow. You can also spread out your loan over a long period of time; the current term for working capital SBA loans is 10 years, which means low monthly payments.
The low interest rates and long terms are huge positives, but it also means that SBA loans are designed for long-term business investments. For example, if you need working capital to bring on additional hires over the next several years or have ongoing capital needs to buy inventory, then an SBA loan may be a good fit. Conversely, if you just need a one-time infusion of working capital to buy supplies, then the other options listed below may be more suitable.
It can be difficult to get approved for an SBA loan. Applicants with a personal credit score above 680 and a profitable business that’s been operating for at least two years stand a good shot of getting approved.
2. Short-Term Online Loans
What it’s best for: Short-term capital needs such as inventory and supplies.
Whom it’s best for: Business owners that have been operating for at least one year with >$50,000 in annual revenues and have credit scores above 500.
What if you need working capital, but you either don’t meet the qualification requirements for an SBA loan or need just a one-time infusion of money for things like inventory or supplies? A short-term online loan may be the answer. These are much easier to qualify more, most requiring just one year in business, at least $50,000 in annual revenues, and a FICO score of 500 or higher. In addition, short term online loans have fast approval and funding in as little as one business day, which should come as welcome news to cash-strapped small business owners.
While they are fast and convenient, short-term loans come at a price. Annual interest rates vary from about 20 to 80 percent! While this might seem shockingly high, keep in mind that these loans are short term–you will pay back the debt in three months to three years, so your total out-of-pocket cost will likely be less than that of an SBA loan.
3. Invoice Factoring
What it’s best for: To cover business expenses that arise while you’re waiting to be paid by your customers.
Whom it’s best for: B2B businesses with cash flow gaps due to slow payment of invoices.
When businesses fail, it’s due to cash flow problems more than 80 percent of the time. Invoice factoring addresses that problem for B2B businesses. Instead of waiting for 30, 60, even 90 days to get paid after selling goods or services, invoice factoring allows you to get paid now. The rates start as low as 2.5 percent for a 30-day invoice.
A lot of businesses that think of invoice factoring think of traditional factoring, which isn’t very small business friendly. Traditional factors often have long-term contracts with hefty fees and required minimums, and are intrusive, requiring client contact to verify and collect payment on invoices. In contrast, online invoice factors (try BlueVine or Fundbox) allow you to pick and choose which invoices you want to submit for funding, and they typically will not contact your clients. Your clients can continue to pay your business by check or electronic payment.
What it’s best for: To expand a startup.
Whom it’s best for: Entrepreneurs in the early stages of expanding a new business.
The first three options that we’ve listed above are suitable primarily for established businesses. Startups, however, are at a disadvantage in obtaining capital because they don’t have a track record to rely on. Crowdfunding sites like Kickstarter or Indiegogo allow you to get small amounts of working capital for your startup from a large number of investors. In return for investor contributions, you have to provide some “reward,” usually a free product or service from your business.
Crowdfunding is great because it has opened up access to capital for startups, and other than the reward, the money is free! However, crowdfunding isn’t right for everyone–it works best for startups that have a consumer product with visual marketable appeal. Also, many crowdfunding platforms are all-or-nothing. This means that if you do not meet your funding goal, you don’t get any money.
5. Peer2Peer Loans
What it’s best for: Small short-term working capital needs.
Whom it’s best for: Business owners with good credit that quickly need a small amount of working capital.
Peer2Peer loans are similar to crowdfunding in the sense that a bunch of investors contribute small amounts of money that you can use for your business. However, unlike crowdfunding, Peer2Peer platforms facilitate loans that have to be paid back with interest in one to five years. Peer2Peer loans are a good “Goldilocks option” for business owners whose credit isn’t good enough for an SBA loan, but is high enough that they can get better rates than a short-term online loan.
With Peer2Peer lending platforms such as Lending Club and Prosper, you can be approved in minutes and receive funding in as little as one week. Rates are reasonable, ranging between 6 percent for the best credit and 25 percent for the low end of the spectrum. Since these are short-term loans, they are best used for things like buying inventory or equipment. Peer2Peer loans cap out at about $35,000, making these a good option for small working capital needs.
Bottom Line on Working Capital Loans
Whatever you may need working capital for, there’s an option for you. Before going out and applying for a bunch of loans, take the time to consider why you need the loan, your credit score, and when you can repay the loan. This will help you narrow down your options to the one that’s best for your small business.