Advantages and Disadvantages of Loan Capital
The advantages and disadvantages of loan capital are the pros and cons of obtaining a working capital loan.4 min read
The advantages and disadvantages of loan capital are the pros and cons of obtaining a working capital loan. Your working capital is the funds you use to keep your company operating on a daily basis. It can include what is spent to generate income, taxes, overhead, what is paid to employees, and other necessary costs. Working capital is something that needs to be easily accessible, but there are times when even profitable businesses don't have enough capital on hand.
A working capital loan is a quick, short-term loan that provides you with the money you need for the success and growth of your business.
Advantages of Capital Loans
There are several important advantages of getting a working capital loan through a lending company instead of a conventional bank. It can take several weeks for a bank to process a loan application. But when you seek a working capital loan, it's often a much faster process. It could even happen within hours, giving you the money you need within a couple of days.
Many traditional bank loans will require a company to have been in business for at least two years before you will be approved for a loan. Private lending companies may approve you after you've been in business for only six months.
Another factor to consider is collateral vs a guarantee for your loan. Many banks require you to provide collateral, which could be property, equipment, receivables, or anything else that can serve to secure the loan. If you suddenly need to liquidate an asset that you used as collateral, you are out of luck. With a working capital loan, you will still make a corporate guarantee, but there is no need to assign specific collateral, which still allows you to keep your business operational.
Disadvantages or Limitations on Working Capital Loans
One disadvantage with these types of loans is they have a higher interest rate when compared to a conventional bank loan. Because they are unsecured and have less strict qualification criteria, lenders consider them riskier. This means they charge higher rates to compensate for that.
Because you get money fast and pay it off quicker, a working capital loan is not a solution for long-term business plans or for a project that needs higher investment capital with a longer repayment period. One example where a working capital loan would be the right choice is for immediate expenses, but it would not be the right option to pay off a balloon payment due on a mortgage.
Advantages of Bank Loans
Some potential advantages of a bank loan include the following:
- Purchase with no liquid assets. The premise behind a bank loan is to provide financial assistance to people who do not have the cash. It can help either a business or individual purchase a home or car, or businesses to purchase machinery. A borrower can apply for a varying amount, up to their creditworthiness.
- Can help drive growth. A bank loan can help drive business growth, especially for private and public sector businesses. Very few businesses likely have enough cash flow to finance a large-scale expansion. In today's business climate, expansion is the only way to achieve sustainable profits. When a business wants to expand, a business loan can be crucial.
- Better interest rates. Bank loans typically offer better finance rates.
- More flexibility. There is additional flexibility with a bank loan that can have long-term benefits.
- Necessary capital for daily operations. Banks may offer special loans that can help a business fund day-to-day operations as well.
- The borrower retains ownership. With a bank loan, the company retains ownership instead of alternatives like raising equity or using venture capital.
- Accounting and taxes. Interest from a loan is deductible, and the borrower can plan and budget for monthly loan expenses.
- Cash discount. Some creditors provide an allowance for cash discounts, which is only an option when you have cash. A loan can provide that cash.
Some potential disadvantages include the following:
- Businesses need good credit for a loan.
- The borrower pays more than purchase price when getting a loan.
- Loans have a strict repayment schedule to adhere to.
- Loan terms can include a partial funding requirement that says if you want to borrow an amount, you need to invest a certain amount of your own money.
- Some loans include prepayment charges and penalties.
- Risk of interest rate rising if your loan includes floating rates, which could make your project no longer viable.
- Many loans include added processing charges.
- Bank may recheck credit points at loan renewal.
If you need help understanding the advantages and disadvantages of loan capital, you can post your legal need on UpCounsel's marketplace. UpCounsel only accepts the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.