Working Capital Loans vs Traditional Bank Loans
Working capital loans vs. traditional bank loans, which is better suited for small to medium sized businesses?
If your business is generating a healthy cash flow and you want to take your business to the next level, what options do you have. For many, a working capital loan is a great way to get the additional capital you need to do just that.
In most cases, a working capital loan is very easy to get relative to a traditional bank loan. The incredible growth in the number of working capital loans underwritten relative to the number of traditional bank loans issued is evidence of this.
The increasing popularity of working capital loans is a good thing for the small business owner. As popularity increases, new lenders come to market to address this need and the result for business owners, is more options, which often means more favorable terms for the borrower.
What is a Working Capital Loan?
Working capital is the money available to operate the immediate and short-term needs of your business. For most, working capital is often in the form of cash at the bank or redeemable and it is used to pay for such things as salaries, marketing campaigns, inventory and other costs that occur within the daily operations of a business. Long-term investments such as plant and equipment are different and usually funded with an equipment loan.
For most small businesses, they may just not have enough working capital on hand to fully fund operating activities. For those businesses having a healthy cash flow, a working capital loan may be the perfect vehicle to close the gap between the funds on hand and those funds needed.
Working Capital Loan vs. Traditional Bank Loan – Application Process
When compared to a traditional bank loan, a working capital loan has many advantages for small business owners. First off, working capital loans don’t have an extensive application process. Rather than relying on credit, working capital loans are assesses based on their cash flow: the amount of money a business brings in and contributes each day.
Traditional loans rely upon the creditworthiness of the business, if there is a credit history or the credit of the owner. For banks, this can be a long and tedious process requiring a great deal of work on behalf of the business owner to complete the application process. We have heard clients tell us in some cases, up to three or four weeks time.
In contrast, the application process for a working capital loan takes a few hours. In most cases, everything can be completed submitted in an afternoon. For the business owner, this frees up a great deal of time to do what they do best, run their business.
Working Capital Loan vs. Traditional Bank Loan – Returning a Decision
Once a traditional bank loan has been submitted, it can take time complete the application review process. A completed loan application is submitted to the Loan Officer at your bank. From there, an application can go before a committee for review and approval. The Loan Committee will review your loan and may either approve, reject or request additional information. This process can be take a couple to several weeks to complete. This is in addition to the time needed to complete the loan application process, which can take several weeks as well.
In contrast, the working capital loan application review process has been largely automated, looking at several different factors. This process can take a matter of minutes if the application process is online and fully automated to up to 24 hours. Regardless, the applicant will have a decision returned to them within a very short period of time relative to a traditional bank loan.
Working Capital Loan vs. Traditional Bank Loan – Unsecured vs. secured loan
Most bank loans will be secured by some asset or assets owned either by the company or the business owner. It can be a building, a piece of land, equipment, the owner’s home, anything. Should the borrower default, the bank has an asset of value that they can take possession of to protect their investment in the loan. In this circumstance, the borrower assumes much of the risk in a default because they may lose the collateral put up to secure the loan.
Working capital loans are uncollateralized and unsecured. This means that the lender loses if repayment of the loan stops. In other words, the lender assumes all of the risk in the case of a default. As a result, working capital loans are much riskier from the perspective of the lender. Working capital loan lenders have more risk, and thus more to lose than a traditional loan lender.
Working Capital Loan vs. Traditional Bank Loan – Fee vs Interest rate
A traditional bank loan will often have an interest rate attached to it. This is the business or business owner’s cost of borrowing the money
A working capital loan may or may not have a stated interest rate attached to it. It really depends upon how the loan is written up. There may be fees or a factor rate, much like a lease in lieu of an interest rate.
Working Capital Loan vs. Traditional Bank Loan – Duration
This is not the risk profile of a loan but rather the length of a loan. For a traditional bank loan, the term could be for any length of time ranging from a matter of days or months, going all the way out to several years. Bank loans may be used to fund long-term investments in the growth or funding of the business. This could be a new plant or to fund the buyout of a partner or to buy a competitor.
In contrast, most working capital loans on the shorter end of a timeline ranging from a matter of months going out to perhaps a year and a half to two years. Working capital loans are short-term loans intended to fund daily operations and short-term activity of the business.
Working Capital Loan vs. Traditional Bank Loan – Repayment
Many traditional bank loans will have a range of payment options ranging from a recurring monthly payment to a lump-sum payment due at maturity. In contrast, working capital loans may exist with a monthly repayment schedule but most will have repayment scheduled every business day of the month. Under this scenario, a daily payment is just the monthly payment divided by 21.
We have many clients who have taken out several working capital loans with us, one right after the other. At first, several of those clients preferred a monthly payment. However, after getting used to daily repayment associated with many working capital loans, the self-discipline they developed making sure that funds were available for daily repayment, has easily transferred over into setting up retirement and college savings programs for their benefit and the benefit of their families.
Traditional bank loans will always have a place in a small business’s lending toolbox as will working capital loans. However, it could be argued that a working capital loan is better suited to small and medium sized business with limited resources but yet have healthy cash flows, whereas traditional loans are ideally suited to larger, more established businesses who have had the time to acquire significant assets
Because of the competition amongst working capital lenders, business owners can obtain the capital needed to fund the growth of their business with terms that work for them. Currently, the industry shows no signs of slowing down. This is all a good thing for borrowers.
If you need a working capital or equipment loan for your business, contact us as we are here to help you get what you need to grow your business to the next level.