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Working Capital Loans
For Small Business
If you've ever wanted to learn about working capital loans for small business, then you've come to the right place. Today we're going to dive right into a topic that is majorly critical for modern-day commerce. In fact, the industry was worth an estimated $36.9 trillion in 2020!
There are some important things to remember about this industry. Besides the obvious demand for working capital, the economy is heavily influenced by business credit.
Let's discuss the industry in-depth.
Why Working Capital Loans For Small Business Is So Important
There are key terms to remember about the lending industry.
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● Inflation
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● Deflation
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● Investment Debt
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● Consumer Debt
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● How Credit Scores Tie In
These terms are paramount in understanding the small business lending industry.
During Inflation
Inflation by any definition means that the prices of goods increase, while purchasing power decreases. An apt example of this is the US Dollar. As more money is printed, the less valuable it becomes.
Any investor understands the concept of supply and demand. When supply exceeds demand, its worth decreases. But when demand exceeds supply, the worth increases. But in the case of the US Dollar, trillions upon trillions have been printed, do the math.
Purchasing power has severely been impacted, which is why the dollar affords you less in modern day.
The lending industry becomes even more lucrative during times of inflation. This is because businesses will need more money to sustain their operations.
Of course, the wealth these lending companies gain is not entirely real. Inflation affects the worth of their money too. $100,000 today is not going to be worth the same when inflation affects it over the course of several years.
The primary dilemma with inflation is that it makes acquiring loans and credit much more difficult. If the Central Bank (which is controlled by the US Government) has to raise interest rates to counter inflation (which it is doing right now!) then the consumer's choices become limited. Saving becomes more logical. However, this doesn't actually stop inflation from growing.
The impact of raising interest rates causes a divide in the working classes. Either you can afford the interest rates or you can't. (Which essentially punishes everyone while the Federal Reserve prints more dollars every day without a second thought)
During Deflation
When deflation occurs, it gives currency a higher purchasing power. Goods and services cost less, which means consumers and businesses can buy more with the money they have.
However, the changes are not always positive, as it means debt is not longer the same. Loans are not about the amount of denominations, it is about the purchasing power being acquired/ loaned.
So when deflation happens, a company might owe a lender $100,000, but that money is now worth $200,000. The revision of interest rates on deposits and loans is controlled in the United States by the Central Banks to control deflation. (That way lenders aren't placed in a negative situation)
However, to say that deflation is anywhere near as bad as inflation would be a gross error. Deflation is a wonderful problem to have! It is a sign that currency is gaining purchasing power. It means companies can generally afford more, and the economy as a whole benefits from interest rate relief.
The lending industry makes more money during inflation, which is why lending companies prefer to put inflation in a positive light. (As if it is wonderful for the consumer to have less valuable money, which is not true)
Investment Debt
Investment debt is a common term in the lending field. In fact, investment debt is highly popular because it is generally a speculative loan. It is loaned on the prospect that the loan will be returned with interest. And it assumes those who received the loan are going to profit from it. Supply, and demand is important to understand here.
When interest rates are high (often as a result of inflation) investment loans are much harder to substantiate. In fact, traditional loans are becoming practically taboo because of how hard they
are to acquire. Alternative lending, online or offline, is dominating the lending market. It is far easier and faster to find alternative sources of capital.
Working capital loans for small business isn't just about receiving funds to acquire something though. These kinds of loans are often used to expand operations or to help cover startup debt.
Which is why companies are now turning to other sources of working capital. If a bank or traditional lending institution isn't keen on supplying money for startups or businesses that need to cover expenses (which is happening more than ever now) that leaves businesses struggling.
Loan brokers are in high demand because they have the connections to lenders that are willing to provide funding with less qualifications. With interest rates rising, and ludicrous standards to apply with a bank, it saves time and money for companies to use a loan broker.
Consumer Debt
Consumer debt is actually more difficult to finance these days than investment debt. With investment debt, there is potential for the loan to bring profit. But consumer debt is generally just that, a debt. The purpose is not for investment or ROI (Return On Investment). Lenders will evaluate the loan based on an individual's credit score and a few other factors.
This is exactly why credit repair has become so popular and lucrative.
A common misconception is that personal credit is always better than business credit for startups. This isn't always true.
How Credit Score Ties In
Credit score is important to qualify for consumer loans.
That being said, lenders usually like to see what a loan is going to be used for, so the process of using personal credit for investing is different. Also, a consumer loan is going to be treated like a new business loan usually.
How To Get Working Capital Financing
We've covered a number of pertinent topics so far. Whether it's been improving one's credit score, the basics of equipment financing, or even using a credit repair agency. Now we're going to talk about how to get working capital financing and what to remember about this highly specific kind of business capital.
In previous articles we discussed the pros and cons of using a working capital loan. Today we are going to discuss the process by which someone actually secures working capital.
Getting Working Capital Financing
To get working capital financing, the appropriate lending option must be used. This means that a traditional loan may not be the right option. Having a loan broker can help with this. Or just having existing sources of funding lined up can shave much time off of the application process.
Here's some important things to remember:
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● Credit score impacts working capital financing tremendously.
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● Working capital financing is not based on ROI. The business credit usually can't be
leveraged because it is probably not keeping up with expenses. -
● Sometimes collateral isn't needed, but sometimes it is.
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● Although lenders are generally more than happy to lend working capital loans, the
economy isn't as favorable during rising inflation. -
● Alternative lending is the most likely place to secure funding of any kind.
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● Traditional lending institutions are far less likely to issue loans when inflation is high.
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● Loan brokers make it faster to get financing. They have contacts and negotiating
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experience.
Let's cover another aspect of working capital financing. The lending options!
Here are some of the most common ways businesses acquire working capital financing:
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Credit Cards
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Vendor Credit
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Business Line Of Credit
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Invoice Factoring
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Merchant Cash Advance (MCA)
6. Invoice Financing
Lending Options For Working Capital Financing
Let's get right into these and discuss what makes each a viable option.
1. Credit Cards (Business & Personal)
Credit cards are easily one of the most common ways businesses acquire working capital. When going through a rough period that isn't going to last for long, having a credit card is an easy solution.
Of course, business credit cards have some other perks for financing and beneficial terms, whereas consumer credit cards aren't as accommodating in some cases.
So if a business needs to get quick working capital, this is a fast way to do it. (And it can look good on a credit score if the business pays back the debt quickly)
Just having a business line of credit can be incredibly useful to organically boost its credit score. However, not all businesses need to cover the same amount of working expenses. Which is why a credit card may not be the right solution. (Especially if the interest rates are high for the credit cards)
2. Vendor Credit
This is an incredibly popular way for businesses to stay operational without having to pay for things like restocking up-front. 30, 60, or even 90 day terms can be used as a "trade credit" allowing the business to pay the bill once their stock has sold or once they have funds to repay the debt in full.
Make no mistake, this is debt, but it is incredibly convenient debt. If stock can be acquired without having to pay the bill up front, the business gains flexibility to manage their expenses with greater accuracy and stability.
Although the economy can make this kind of working capital financing ineffective in the long term, having 3 months to pay for stock is wonderfully beneficial for businesses in years like 2020.
3. Business Line Of Credit
If you have ever sought working capital financing, then you are probably familiar with this loan option. It is convenient, usually covers a hefty sum, and gives you more than a few ways to approach repaying the loan.
However, a business line of credit is much harder to qualify for it. The business needs a record of success and an excellent credit score is needed.
Which again brings up the point about why alternative lending sources are becoming more easily attainable. These lines of credit are often issued from lending institutions and banks. (Though there are exceptions)
4. Invoice Factoring
Although not nearly as popular as other loan options on this list, invoice factoring is a way to quickly capitalize on existing invoices that are owed to you. If the agreement is worth a certain amount of money, an invoice factoring company will buy them from you, take a fee and collect the rest. This means you won't get the full amount you are owed, but it does present a way to get fast cash. It can be confusing for your customers however, since you won't be handling the payments anymore.
You are basically selling money owed to you when you use invoice factoring.
5. Merchant Cash Advance (MCA)
This is probably the most popular way that businesses acquire working capital financing right now. It requires no collateral, and the fees to get a loan like this are proportional to your business' credit card sales.
There are a few things to remember about this financing option. The first is that you need to have a history of credit card sales. The second thing to remember is that the fees for merchant cash advice add up quickly.
The convenience of MCA is contrasted by its interest rates. It is recommended that you evaluate all options before running to use merchant cash advance since you might qualify for something better.
Although, it is proven that you can setup a merchant cash advance loan within a day or two. It is simple and quick.
6. Invoice Financing
Pretty similar to invoice factoring except that you stay in control of your invoices. This can be highly beneficial so your customers don't know you used an invoice factoring company too.
About A Working Capital Loan
A working capital loan is essentially just a loan for businesses to cover expenses or expand operations. Although not necessarily the most obvious source of funds for businesses, many will apply for traditional funding. However, with inflation rising and banks raising their minimum requirements, many corporations (big and small) are now seeking alternative funding sources.
In our last article we dove into key fundamentals about how inflation, deflation, certain kinds of loans, and the economy impact lending in general.
Now we're going to discuss exactly what kind of use a working capital loan has. Let's get right into this!
What Is A Working Capital Loan Used For?
A working capital loan is specifically used to cover company expenses, but there are subtleties that determine whether they should be sought after. It isn't a loan that is lightly taken.
Here are some reasons that a working capital loan isn't always positive:
● The loan is generally leveraged against the owner's credit, not the business.
● A working capital loan is not an investment loan and the owner may have to "securitize"
to get the loan if their credit score isn't great.
● While interest rates may not be ideal, a working capital loan is generally easy to acquire.
Why Isn't The Business' Credit Used For A Working Capital Loan?
Because the business is in need of capital to cover operating costs, there is no way to leverage business credit here. If the business is not making enough money to cover their operating costs, this means they are not profiting, they are losing money.
Remember, credit score is a measurement of "credibility", or the ability to pay back debt. In this case, a business that needs money just to function has zero credibility. Thus, the ability to pay back debt cannot be measured by the business' performance. The operator of the business is now the only leverage to qualify for financing besides the business assets.
This is where a business might have to "securitize", which is just listing assets to substantiate the loan application.
What Does It Mean To Securitize?
Here's a scenario, a owner or operator of a business doesn't have the necessary credit score to qualify for a working capital loan. This isn't uncommon in the slightest. When this occurs, and the business' credibility can't be listed, the owner must "securitize."
This means that their current debt and assets must be listed so that there is substantial proof that they defaulting on the loan isn't fatal for the business. This makes it clear to the lender that the owner has something to leverage towards the loan.
How Is A Working Capital Loan Easy To Acquire?
Because the business isn't entirely without merit (since the loan does in fact continue their operations) many lenders welcome the opportunity to loan them money. Especially when a business is just experiencing a slow period but regularly makes steady profits.
Once the business is back to their busy period, the loan is quickly paid off. (In most cases anyway)
Were These Loans Good After 2020 Hit?
Actually, no. Many companies defaulted on loans due to lockdowns and economic problems. Supply lines were heavily impacted, causing delays and in some cases complete lack of stock. This mean companies couldn't produce their products and stores couldn't stock their shelves.
Online businesses that shipped physical products were the same way, only the online space was still widely used. In fact, online businesses grew during 2020, especially tech companies like Microsoft, or major shopping giants like Amazon.
Business didn't fully rebound, however, as 2020 marked what is frequently referred to as a "Global Recession."
This meant interest rates were spiking, financing was harder to get, and only those with "essential" roles were staying afloat.
What Kinds Of Businesses And Workers Were Doing Fine In 2020?
Loan brokers were among the most lucrative workers in 2020. Financing was crucial for millions of businesses, and the brokers had the means to get those loans for them.Tech workers, sales specialists, and those who could work from home saw little to no change besides a shift in employers sometimes.
These industries in particular were doing well despite economic issues everywhere:
● Any kind of digital online-only business. (Exceptions would be if they were drop shipping goods they couldn't stock)
● Online learning companies.
● Digital communications companies.
● Online encryption services.
● Digital retailers or shopping giants.
● Technology groups with more than physical technology to sell.
● Online artists & graphic designers.
● Marketing specialists with experience online.
While businesses in these fields obviously took out working capital loans, the rate that they did was far less compared to the retail industry.
Does A Working Capital Loan Require
Collateral Or A Down Payment?
If the loan requires collateral this can cause the interest rates to go up. This is generally what occurs when the owner's credit score is not high enough to qualify. Assets or something of value is used to substantiate the loan.
This is actually one of the reasons why so many businesses sought out a business loan broker. It made sense to use someone who could connect them with a more flexible source of funding. Even business owners with good credit were having a strenuous time qualifying for a working capital loan in 2020.
There was a lull in the lending industry where alternative lending sources weren't becoming more popular. But during and after 2020, the lending industry saw a massive shift from traditional lending sources. Today, alternative lending options are beating banks and standard lending institutions by huge margins.
That's probably why you are reading this article in the first place. Getting a loan isn't about showing up to a bank and expecting a fair deal. Finding financing is now about who you know and how you structure the deal. A Bank doesn't allow you to utilize your contacts or your contract terms usually.
Many are backed by government support, they often don't need you, you need them and they know it.
6 Uses for Working
Capital
Now that you have started a business, all of a sudden you’re seeing ads and offers for business financing. You’re probably thinking “I don’t need that, I refuse to put myself into more debt.”
Hey, we get it. Finances are tight and you don’t want to take up more than you can chew.
Working Capital can be used in a lot of different ways. Once funded, you can use that money for whatever you see fit. You don’t have to use it all for one specific thing. It can be dispersed all around.
When used correctly, you can utilize the money to the advantage of your business!
We’re here to tell you all the different ways working capital can be used to help you make a decision.
Purchase inventory
If you own a retail store odds are you have to buy inventory in bulk to get a cheaper rate on the purchase. Don’t have the money? You can use your capital towards it! You will save money and be able to make a profit for your business.
Marketing
As a business owner you don’t have time to do it all yourself. With capital you can hire freelancers and/or marketing companies to boost.
Payroll
When business has been slower
than expected and you can’t afford to pay your employees. Capital can cover costs so you won't fall behind!
Expansion
Whatever you need to grow! Whether it be hiring more employees (back to #2 which is payroll) or moving to a bigger space.
Renovations
Does your business space need
a makeover? Maybe you’ve
been delaying that new toilet
you desperately needed.
Use capital to revamp your
business.
Expenses
Use capital to cover business expenses such as taxes. Maybe something came up that you
didn't expect. This way you
won’t have to break the bank to
make ends meet.
Charles L Green,
CEO & Founder of Main Source Lending LLC
As you can see, there are multiple uses for working capital. It is meant to benefit your
business. If you’re still on the fence or if you're not sure if you're qualified, talk to one of
our finance managers and they’ll be able to help you determine what direction you
should take. Our goal is to help your business succeed not fail.
