All working capital is not created equal. They type of working capital you should apply for depends on what stage (seed/startup, growth, expansion stages, etc) your business is in. There are a variety of different options for working capital out there, and you should understand what they are before you approach a lender to apply for financing. Applying for the wrong type of working capital could get you into major trouble. It could hurt your business more than help. Below are a few common types of working capital that small business owners consider based on the age/stage of their business.
- SBA Microloan (Seed/Startup Stages) – SBA microloans were specifically designed for startup and microenterprise business owners (with less than 5 employees). Additionally, they work well for business owners in this category who have less than perfect credit and wouldn’t qualify for traditional small business loans (from banks like Chase, Fifth Third, etc). In fact, the SBA recommends that new business owners (i.e. startups) apply for a microloan before seeking higher levels of funding. Most microloans go up to $50,000 and can be used for a variety of working capital purposes (except the purchase of real estate or paying off existing debts).
- Unsecured Business Loans/Unsecured Business Lines of Credit (Any Stages) – This type of working capital works well for startup or existing businesses where the owners have an exceptional personal credit history. It also works well for businesses in high risk industries (such as real estate). For an unsecured business loan or unsecured business line of credit, you won’t have to provide collateral to secure the financing however, you will have to provide the lender with a personal guarantee. If you have excellent credit and don’t mind using your personal credit to guarantee the financing, this may be the best way to go.
- Traditional Small Business Loans (Growth Stage and Above) – This type of working capital works well for businesses that are established (at least 2 years old or older) and generating at least $500,000 in revenue. Traditional lenders (I.e. Chase, Fifth Third, Bank of America) prefer to lend to businesses that have a track record. Startup businesses need not apply (you most likely won’t get approved anyway, so don’t waste your precious time)! Often times, traditional lenders will check the personal credit of the business owner (as well as the business credit history). Therefore, having good personal and business credit is a must. Collateral may also be required for approval and some industries are restricted no matter how well the business is doing. (Lenders have a restricted industries list which includes businesses in certain industries that they will not lend to no matter what. A good example would be real estate investment).
- Merchant Cash Advances (Growth Stages and Above) – This type of working capital works well for businesses that are established (at least 2 years old or older) and have a high volume of daily credit card sales and/or deposits. I’ve seen many people get into trouble when obtaining a merchant cash advances. Just about all merchant cash advance lenders require daily or weekly payback (not monthly payback like traditional financing sources). It can drain your business bank account if you don’t have enough revenue coming in on a daily basis. Good credit is not always needed to obtain a merchant cash advance (because it based on cash flow). However, that doesn’t mean it’s your only option if your credit is bad (see: microloans).
- Accounts Receivables Financing/Invoice Factoring (Growth Stages and Above) – This type of working capital works well for businesses that are established (at least 2 years old or older) and have a significant number of clients who have been invoiced. If your clients pay on time and have a good track record, yet you have to wait 30 days (or more) to be paid by them, selling your receivables at a discount (to receive the money sooner) may be the best way to go. There are many accounts receivables financing companies out there that will advance you up to 97% of your outstanding invoice amounts if you sell your receivables to them. In some cases you will need to have a pretty good credit history and provide collateral to the financing company to be approved.