Are you considering a working capital loan to help you bridge the holiday season?
Here's what you need to know before you borrow.
Last month, we put together a checklist to help you put the pieces in place for a super successful holiday season.
But today we wanted to go a little more in depth on one particular issue:
Cash flow.
When your business is young, all you can think about is growth. It seems like you can never have too many sales.
And then that one holiday season hits. The one that looks like a battle scene from Lord of the Rings. Only instead of orcs flowing over the walls, it’s sales. And you’re happy to see them…or you would be, if you thought you had enough product for everybody who wants to buy from you.
Cash Flow Issues – A Good Problem to Have
Say you do a promotion that goes way better than you expected. Or maybe your business gets a mention on a popular website. Suddenly, the demand for your product is higher than your inventory can supply.
It’s a good problem to have. But it is still a problem.
For big corporations, the solution is simple: allocate some of your current profits to buying up extra inventory on the fly. But small, independent businesses don't always have that option.
So where do you get the extra money you need to meet unexpected demand?
A lot of businesses turn to working capital or merchant cash loans.
Working Capital Loans
You've seen those roadside stands advertising cash against your paycheck? A working capital loan is a lot like that. You get a cash advance on the money you expect to make over the next few months, and the loan company gets a regular cut of your profits until you pay them back. (Plus interest, of course.)
As an accountant, I have to be honest: loans like these set my teeth on edge. Those high interest rates plus the short payback term spell financial risk.
But as a small business owner, I totally get it. You need cash fast and you don't have the time to wait for a bank to approve your loan. Maybe your credit isn't great or you don't have the documentation needed to apply. A working capital loan offers you easy access to the cash you need for a temporary quick-fix for your inventory shortage.
Fortunately, there are ways to make sure that a working capital loan works for you, and that you don't end up working for it!
We’ve created a side-by-side comparison of the three most common funding sources for working capital loans. We've also compiled some best practices tips to make sure your temporary cash-flow solution is just that: temporary and a solution.
PayPal Loans
- You're eligible for a PayPal loan if you use the service to accept credit cards and have had at least $20,000 in PayPal sales in the past year
- The amount you can borrow is based on sales — as they increase, the amount you can borrow increases, too
- Borrow $1,000 to $85,000
- No interest rate; instead, you pay a flat fee based on your PayPal sales volume and a percentage of your sales. If you decide to pay back with a smaller percentage of your daily sales, PayPal charges you a higher fee; devoting a higher percentage of your daily sales to repayment results in a lower fee. (This translates to about 15% to 30% APR.)
- Loan payments deducted daily from your PayPal sales
- Minimum payment (10% of your total loan amount (loan + fixed fee) is required every 90 days, regardless of sales
Pros:
- Quick application process
- You get to choose the percentage amount deducted from your daily sales — 10%, 15%, 20%, 25% or 30%
- On days when you don’t have any sales, you don’t pay anything
- no specific time frame for repayment
- Funds are deposited to your account within minutes
- No penalties for additional or early payments/missed and catch-up payments
Cons:
- Default could result in the balance becoming due immediately, and the debit of your funding methods (bank account or debit card)
- If, after 30 days, catch-up and uncollected payments account for more than 50% of the cumulative balance due, your loan could go into default, the entire balance could become due, and limits may be placed on your account
- Loan fees vary greatly, and are set on a case-by-case basis. You will not know your loan fees by repayment percentage until you apply
- Once the loan has been received, you cannot change the repayment percentage you agree to during the application process
Amazon Lending
- Amazon recently began offering short-term loans to select registered sellers. (If you’re an Amazon seller, you may have received notice from them that you have prequalified for a loan.)
- Fixed monthly payments are automatically deducted through your Seller Account.
- Takes about 5 business days for the money to show up
- 4-6 month payback term
- Loans are targeted for inventory financing (i.e. funding can only be used to buy more product)
Pros:
- Huge range–you can borrow as little as $1000 or up to $800k
- 10-14% interest rate (lower than most average short-term loans)
- Get approved in as little as 24 hours
Cons:
- You can’t apply for the loan on your own. Amazon will reach out to you if they determine your business is eligible
- You’re restricted to using the funds only for Amazon purchases.
- You’re not in control of making payments; automatic deduction is done by Amazon
- If you should default on the loan, Amazon can do things like hold your inventory hostage or redirect your profits from your Seller account into loan repayment.
Kabbage
- One of the easiest loans to get, no matter what kind of online business you're in.
- Funding range between $2000-100,000
- Businesses that have been operating for at least 1 year and have $50,000+ per year in revenues may get approved.
- Loan terms are calculated based on a variety of financial factors, including revenue, how long you've been in business, credit score and other information.
- Application is paperwork-free–you simply connect your business checking account, bookkeeping software (like Xero) and seller/payment platform (eBay, Shopify, Etsy, etc.). The more accounts you link, the more information Kabbage can use to evaluate your application.
- Each month, you pay back a percentage of the principal (amount borrowed) plus a fee. For the first two months, your fee is 1-12% of the total amount you borrowed. (This percentage is based on the data you've supplied. For the remaining four months, you pay 1% of the total amount you borrowed.
- Operates like a line of credit. You only pay interest on funds that you withdraw from your line.
Pros:
- Fast application process with same-day approval
- Funds available in a few days
- Longer repayment term—6-12 months
- No penalty for early repayment
Cons:
- Extra high interest rates— ranges from 32% to 108%
- Complicated repayment structure
- No reward for early repayment
Working Capital Loan Tips
Don't borrow more than you need. Just because $100k is available to you doesn't mean you should take it. It's not free money; it's a loan that you'll have to pay off.
Don't let the funds sit in your account. Whatever funds you aren't putting to work are like “dead money.” Remember, you're actually paying a fee for having those funds available; not using them means you're losing money.
Restructure your budget to include the automatic repayment. The last thing you want is for your monthly loan payments to surprise you and throw your whole business budget out of whack.
Find a way to repay early without actually repaying early. Using your working capital funds in a smart way will throw plenty of profit into your pocket. Allocate a good chunk of that profit into a separate account that you can draw from each month, when the loan repayment happens. That way, you're setting the money aside but not being penalized for early repayment.
