The Pros and Cons of Working Capital Loans

By Carl Faulds

Working capital is crucial to every company. Without it, you cannot pay your staff, purchase stock, invest in growth, or undertake any of the other activities essential to stay in business. Yet almost every firm encounters a shortfall at one time or another, and business finance has become far more difficult to obtain since the financial crash of 2008.

In simple terms, a working capital loan is a specialised type of loan designed to meet your everyday operating costs. Unlike other business loans, you will generally not be required to state the purpose of the borrowing, as the loan will be short-term and clearly intended to cover a cash flow issue or urgent investment in growth.

So what are the advantages and drawbacks of working capital loans?

The Pros

You will have the cash on hand to deal with any cash flow problems. Even the most successful business can find itself facing insolvency if it can’t pay its bills. In fact, a phase of rapid growth can be particularly dangerous, as you will need to invest in new stock, people, or equipment before your new customers pay you.

You can keep ownership of your company. Funding from an equity investor can give you a substantial injection of cash, but at a high price–the dilution of your own equity and a reduction in your autonomy. Borrow from a bank or alternative lender and your only commitment is to repay the finance on time and in full, allowing you to continue to run your business however you see fit.

You may not need to put up any collateral. Business loans can, of course, be either secured or unsecured, and unsecured working capital loans tend to be offered only to businesses with a good credit history and little risk of default. If you qualify, you will not need to stake your premises, plant, equipment–or even worse, your home–to get the funding you need.

You can borrow and repay quickly. Working capital loans are designed to give you a quick shot in the arm, after which you can return to business as usual. In other words, you won’t need to budget for repayments for months or years down the line.

You can spend the money however you want. Chances are your lender will place few, if any, restrictions on how you use the finance; they just want you to stay in business.

The Cons

You have to repay the loan. This sounds obvious, but it’s all too easy to forget. Even if the injection doesn’t give your business the shot in the arm it needs, you will still have to repay the capital and interest in full.

You may need to put up collateral. As stated above, unsecured business loans are difficult to obtain in the current climate. Staking your business premises or equipment on a loan can be risky. Putting your home on the line–which may be the only option if your company has few assets–can have terrible repercussions if your business fails.

You may be charged a high level of interest...particularly if you succeed in obtaining unsecured lending. This can substantially increase the total repayments you will make compared to a secured loan, and will of course make the payments more difficult to afford. Look around.

Your credit rating will be compromised. Every time you take out a loan, it will be noted on your credit history. The more you borrow, the higher your risk, and the more interest you are likely to be charged. What’s more, if you repay late, your credit rating will plummet, creating significant problems for your company in the future.

You may have to repay quickly. As already noted, working capital loans are intended to cover a brief hiatus in your cash flow, so the lender will require relatively rapid repayment. This type of borrowing is not suitable to meet longer-term business goals, for which you should seek more substantial funding with a longer repayment period.

As can be seen, working capital loans can be something of a double-edged sword–but there are times when almost every business needs one. With this guide, you will be able to make the right decisions for your circumstances and for your company.