Working capital loan or line of credit: which fits your business?

Both products fund the same kinds of costs: payroll, materials, inventory and the gap before customers pay. They work very differently, and picking the wrong one usually means paying for money you don’t use, or running out when you need it most.

How a working capital term loan works

You receive the full amount up front and repay it in fixed payments, usually monthly, over a set term. Because the amount and schedule are known, it is easy to budget and easy to compare offers: look at the APR, the term, the payment and any fees.

• Best for a known, one-time need: a large job, a seasonal inventory buy, or the ramp-up after a new machine arrives.
• You pay interest on the full amount from day one.
• When it is paid off, it is done. You apply again for the next need.
• Fixed payments make it easy to see whether the need will pay the loan back.

How a line of credit works

A lender approves a limit. You draw what you need, repay it, and draw again. You generally pay interest only on what you have drawn, though some lines charge annual, maintenance or draw fees. Some newer lines turn each draw into its own short fixed-payment loan, which combines the flexibility of a line with the discipline of a term loan.

• Best for recurring, unpredictable timing gaps, such as waiting on receivables.
• Flexible, but easy to leave a balance outstanding permanently.
• Lines are often reviewed each year and can be reduced if the business weakens, just when you might need them.
• Some require you to pay the balance to zero for a period each year.

A quick test

If you can write down the amount, the date you need it and the date the money comes back, a term loan is usually cleaner. If the need comes and goes every month, a line is usually cheaper because you only pay for what you use.

Two examples

A roofing contractor wins a $400,000 commercial job that pays in three progress draws. Materials and crew costs for the first phase come to $120,000 before the first draw. That is a known need with a known repayment date, a natural fit for a term loan sized to the gap.

A parts distributor sells to repair shops on 45-day terms. Every month, some invoices pay early and some late, and the gap swings between $20,000 and $80,000. A line of credit lets the business draw only what the month requires.

Where equipment fits

Neither product is the right home for long-lived equipment. A machine that lasts 7 to 10 years should sit on an equipment loan or lease with a term to match. Using your line of credit to buy equipment uses up the flexibility you will want later, and a short working capital loan makes the payment on a long-lived asset unnecessarily high.

Comparing offers

Compare on APR, not on a factor rate or a monthly rate. Ask what is deducted from the amount you receive, whether there is a prepayment penalty, what collateral is taken, and whether a personal guarantee is required. A reputable lender puts all of this in writing before you sign.

• APR and total cost
• Amount you actually receive after fees
• Term and payment frequency (monthly, weekly or daily)
• Collateral: specific equipment, or a blanket lien on all business assets
• Personal guarantee requirements
• Renewal and review terms for lines

LenderCloud offers working capital alongside equipment financing, priced as an APR with monthly payments. See our working capital page for details.