Pros and Cons of Working Capital Loans For Small Businesses

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Key takeaways

Working capital loans offer fast funding and can have relaxed eligibility requirements, but they have small loan amounts and short repayment terms with frequent payments.
Interest rates for working capital loans can be higher than other types of loans, and certain loans may use factor rates instead of interest rates.
Working capital loans are a type of short-term business loan that can help businesses cover immediate costs like payroll, inventory or rent.

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.

Utilize business credit cards to build business credit

If you have good-to-excellent credit, consider keeping a business credit card on hand to cover working capital needs you can pay off quickly. On top of building business credit, you can avoid interest charges if you keep your balance paid in full each month.

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.

Convert factor rates into interest rates to understand the true cost of borrowing.

Before accepting a loan that uses factor rates, make sure you convert it to interest rates to compare with other loans and better understand how expensive these loans are. Our guide on factor rates will show you how.

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

Yes, many types of SBA loans can be used for working capital. You can use the organization’s SBA 7(a) loan, CAPLine lines of credit, Community Advantage or SBA Express loans to cover working capital needs.
Each lender sets its own requirements to qualify for a loan. Typically, online lenders have lower requirements than banks or credit unions, and you can qualify with a credit score of 500 or even lower. A low credit score, however, will mean high borrowing costs.
Working capital loans help cover short-term borrowing needs. They offer many benefits, including quick approvals and funding, simple loan applications and lower eligibility requirements, than other types of business loans.