Working capital is the lifeblood of a successful business. When running a startup, entrepreneurs sometimes rely on their own personal resources to fund the business. An alternative may be to borrow funds through a short-term or long-term loan. These loans offer flexibility to cover day-to-day expenses and support company growth. However, choosing the right option will depend on your specific business needs. In this post, we provide an overview of short-term and long-term loans and key advantages for each.
Meeting Short-Term Business Needs
What is a working capital loan?
As the name suggests, working capital is the money available to operate the immediate and short-term needs of your company. A working capital loan is a short-term (one year or less) line of credit from a bank, credit union, or other alternative lender. This type of loan is intended to finance everyday expenses involving the daily operation of a business.
A working capital loan has a variable rate of interest that is tied to short-term interest rates (APR, LIBOR), and the lender makes a certain amount of money available to the business to draw (i.e., borrow) as necessary. The borrower only pays interest on what is borrowed.
Why establish a working capital loan?
Because aligning monthly revenue and expenses is hard to achieve, a working capital loan provides ready access to capital to keep a business operating. For example, a working capital loan allows a business to borrow money to pay routine expenses, such as rent, payroll, invoices, taxes, insurance, etc. It also allows a business to borrow money to do things like purchase inventory or equipment or invest in advertising. The business repays the loan over time. This type of loan can help a business owner establish good credit history and good business practices, which can be particularly important for an entrepreneur or first-time business owner.
Short-term loans can be unsecured or secured. For secured loans, lenders will likely require a personal guarantee and/or need to pledge “all assets” (i.e., revenues, receipts, intellectual property rights, contracts, equipment, inventory, etc.). If a default occurs, the lender has the right to these assets.
Key advantages of working capital loans
- The loan provides an infusion of capital when needed to cover expenses.
- You maintain control of the business.
- Often, collateral is not required to secure the loan, although in these circumstances excellent credit history is needed.
- Borrowers can access money quickly.
Meeting Long-Term Business Needs
What is a long-term capital loan?
A long-term commercial loan is money borrowed for more than one year from a bank, credit union, or other alternative lender. This type of loan has a fixed interest rate that is usually tied to longer-term interest rates (i.e., 3, 5, or 10-year Treasury Rate plus a spread). The borrower pays principal and interest in equal installments over time .
Long-term loans are typically secured. Lenders will likely require a personal guarantee, a pledge of the asset that you acquire with the loan, and/or a pledge of “all assets” (i.e., revenues, receipts, intellectual property rights, contracts, equipment, inventory, etc.). If a default occurs, the lender has the right to these assets.
Why establish a long-term capital loan?
If a business needs to buy capital equipment, buildings, other businesses, or undertake construction projects, a long-term loan may be a better option. All the money is disbursed up front except for construction loans, which are disbursed during the construction period.
Key advantages of long-term capital loans
- These commercial loans can be made in very large sums, allowing you to cover the cost of larger projects with a single loan.
- You maintain control of the business.
- You can get access to funds quickly.
- You can avoid large payments up front, which can be attractive to most startups.
Whether you are borrowing to cover daily expenses or to purchase equipment, it may be worth exploring short- and long-term commercial loan options. Regardless of the loan you choose, there are benefits to be had from working capital that supports business growth.