Working capital loans: how they work and what they cost

A working capital loan gives you a lump sum to cover the everyday costs of running the business: payroll, inventory, rent, a gap between paying suppliers and getting paid. It is a real loan with a set repayment schedule, which usually makes it cheaper and more predictable than a cash advance. This guide explains how to read an offer and compare two of them fairly.

Typical amount

$10,000 to $500,000, depending on revenue and credit

Typical cost

Wide range, from single-digit APRs at banks to well above 30% online

Repayment

Fixed daily, weekly or monthly payments

Term

Often 3 to 24 months for short-term loans, 1 to 5 years for term loans

Fees

Origination fees commonly 0% to 5% of the loan

Best for

A known, one-time need you can repay on a schedule

Two kinds of working capital loan

The phrase covers two products that behave quite differently.

• Short-term loans from online lenders. These run from a few months to about two years. Payments are often daily or weekly and are drawn automatically from your business account. Underwriting leans on your bank statements and revenue, decisions can come within days, and the price reflects that speed and risk.
• Term loans from banks and credit unions. These usually run one to five years with monthly payments. They ask for more paperwork, such as tax returns, financial statements and sometimes collateral, and they take longer to close. In exchange, the rate is typically much lower.

An SBA loan is a third route for longer-term needs. It is a bank loan partly guaranteed by the government, with longer terms and more documentation still.

How a loan differs from a merchant cash advance

A merchant cash advance is a purchase of your future sales, priced with a factor rate. A working capital loan is debt. You owe a stated principal, the lender charges interest or a fee for its use, and the payment schedule does not change when your sales do. That has three practical consequences.

• The cost is easier to see. Loans usually come with an interest rate, an APR or both, so offers are simpler to compare.
• There is no reconciliation. A slow month does not lower your payment. You need the cash flow to cover it either way.
• Different rules apply. A loan is generally governed by lending law, while an advance is structured as a sale of receivables. The protections that come with each differ, and the details depend on the state.

Flat fees vs interest on a declining balance

This is the part that trips up most owners. Lenders price loans in one of two ways, and the same headline percentage can mean very different costs.

Amortized interest is charged on whatever you still owe. Each payment covers that period's interest plus some principal, so your balance falls and the interest charge falls with it. Pay the loan off early and you stop paying interest from that point.

Flat or fixed-fee pricing works out the total cost once, as a percentage of the original amount, and spreads it across the payments. Some lenders call this "simple interest", which is confusing, because interest on a declining balance is technically simple interest too. What matters is the result: you pay the fee on the full amount for the whole term, even after half of it has been repaid. Paying early often saves little or nothing unless the contract includes a prepayment discount.

Here is the same $60,000 over 12 months, priced both ways.

The flat "15%" sounds cheaper than "18%", but it costs about $3,000 more and carries a higher APR, because the fee is charged on money you have already paid back. The origination fee matters too. On the amortized loan, $1,800 comes out at funding, so you receive $58,200 but repay as if you had borrowed $60,000.

Fees and what typically drives the price

The origination fee is the big one. It is commonly a few percent of the loan and is usually deducted before the money reaches you. Other charges to look for include underwriting or documentation fees, late fees, returned-payment fees and, on some loans, a prepayment penalty.

The rate you are offered typically depends on your time in business, revenue, cash flow, credit history, any existing debt and whether you can offer collateral. Banks price mostly on credit and financial statements. Online lenders put more weight on recent bank activity, which is why they can say yes faster and why they usually charge more.

When a working capital loan fits, and when it doesn't

A loan is often a sensible choice when:

• you need a fixed amount for a defined purpose, such as a bulk inventory order, a hire or a move;
• your cash flow can carry a fixed payment even in a slower month;
• you want a predictable payoff date and a cost you can calculate up front.

It is usually the wrong fit when the need is recurring or unpredictable. Borrowing a lump sum for occasional shortfalls means paying for money that sits idle, and a business line of credit often suits that better. If the money is for a specific machine or vehicle, equipment financing can be cheaper because the equipment secures the loan. If your cash is tied up in unpaid invoices from business customers, invoice factoring may solve the real problem. And a loan taken to cover ongoing losses rather than a timing gap tends to add a payment without fixing the cause.

Contract terms to check

• Net proceeds. The amount that will land in your account after every fee.
• Pricing method. Whether interest is charged on the declining balance or as a flat fee on the original amount.
• APR and total repayment. Both, in writing, before you sign.
• Payment frequency. Daily and weekly payments feel small but add up. Convert them to a monthly figure and compare it with your cash flow.
• Prepayment. Whether paying early saves interest, earns a discount, or triggers a penalty.
• Personal guarantee. Most small business loans require one. Know whether it is limited or unlimited.
• Collateral and liens. Many lenders file a UCC-1 lien on business assets, which can affect future borrowing.
• Default and renewal terms. What counts as default, and whether the lender can offer to "renew" by rolling your balance into a new loan with new fees.

What lenders typically look at

• Time in business, often at least 6 months online and 2 years at a bank
• Monthly or annual revenue, and how steady it is
• Recent business bank statements, and for banks, tax returns and financial statements
• Personal and business credit history
• Existing debts and advances, and how much of your cash flow they already take

When you are ready, you can check your options and we will show the real cost of anything you are offered.

Common questions