Here are six common ways to raise working capital for an existing business, including average interest rates and the pros and cons associated with each financing option. They are listed roughly in order of cost, with the lowest interest rate option listed at the top and most expensive option listed at the bottom.
#1. Loans from the Small Business Administration (SBA Loans)
Average Annual Interest Rate : 6-9%
For Small Business Administration loans, the SBA guarantees that it will pay the lender up to 75-85% of the loan should the business owner default. It is not the SBA that actually provides these loans. SBA lending partners, such as banks, community development organizations, and microlending institutions actually issue the loans.
Because the SBA is assuming much of the risk, these loans generally have lower interest rates than other commercial loans and longer repayment periods. In fact, if you qualify for an SBA loan, this is likely the lowest interest rate that your business is eligible for in the entire lending market.
SBA loans are typically easier to qualify for than bank loans, but there are still some things that banks expect to see in a strong SBA loan application. Your credit score must be good, around 600. Moreover, although the collateral requirement isn’t as strict as it is with traditional commercial loans, banks hesitate to lend a large amount of money through an SBA loan without sufficient collateral. The reason for this is because the bank is still on the hook for the part of the loan that isn’t SBA-guaranteed, and whatever collateral the borrower puts up is shared by the SBA and the bank.
Pros of Getting an SBA Loan
- Lowest interest rates of all financing methods
- Longer terms than traditional commercial loans
- Easier to qualify for than a traditional commercial loan
Cons of Getting an SBA Loan
- Your business typically needs to be in operation for at least 2 years
- You typically have to have a good personal credit score (600 or higher)
- You have to sign a personal guarantee (meaning you are personally liable if your business cannot pay the loan back)
SBA Loan Resources
- Use Our SBA Loan Calculator To See If You Qualify For An SBA Loan
- Read our Full Guide To SBA Loans
- Visit Our Recommended SBA Loan Provider
#2. Traditional Commercial Loans
Average Annual Interest Rate: 5-10% (Real Estate Backed Loans), 9-15% – (Non-Real Estate Backed Loans)
Commercial loans are loans that are given to a business by a lending organization, such as a bank or credit union. Your business generally needs to have been operating for at least 2 years to qualify.
Because there is no SBA guarantee, commercial loans generally more difficult to get, requiring high levels of collateral (real estate, business equipment) and demonstrated business success. However, if you can get a commercial loan, the interest rates are generally lower than any other financing method, with the exception of SBA loans.
If you are looking for a smaller loan (under $100,000) commercial loans are probably not a good option. Commercial lenders rarely give loans for under $100,000 because they have to do just as much work to process such a loan with less return.
Pros of Getting a Commercial Loan
- Lower interest rates than most financing options
- Can borrow significant amounts of money
Cons of Getting a Commercial Loan
- Have to have generally been in business for at least 2 years
- Not effective way to borrow less than $100,000
- Need substantial collateral
- Need a great personal credit score (660 or higher in most cases)
To learn more about the different types of commercial loans and how your business can qualify, check out our in-depth article, Commercial Loans: The Ultimate Guide for Small Business Owners
#3. Peer-to-Peer Loans (P2P)
Average Annual Interest Rate: 6-30% (generally 15% or higher)
P2P loans are basically loans that are funded by willing individual or institutional investors to you through a “crowdfunding” website like Lending Club. These sites allow you to go online, get an instant loan rate quote (2-5 year term), and then connect you with interested investors. If your submitted paperwork matches up to the information you provided on the online form, you can generally get your funding in 2 weeks or less.
Most P2P lenders, such as Lending Club, have both personal and business loans. You can borrow a larger amount through a business loan, up to $300,000 versus up to $35,000 for a personal loan. However, business P2P loans can be difficult to qualify for, requiring you to be in business for at least 2 years with over $75,000 in annual revenue. If you cannot meet those minimums, then you can take out a smaller personal loan and use it to fund your business.
Whether you get a personal loan and use it for business purposes or a business loan, you have to have a good credit score–typically 620 or higher–to be successful on P2P platforms.
Pros of Getting a P2P Loan
- Relatively easy to get (if you have a good credit score)
- Can get your money quickly (about 2 weeks or less)
- Lower interest rates than alternative lenders, merchant cash advances, and invoice factoring
Cons of Getting a P2P Loan
- Hard to qualify for a business loan
- Can only borrow up to $35,000 as a personal loan
- Have to have a great personal credit score (620 minimum but generally higher)
- Higher interest rate than SBA or commercial loans
P2P Loan Resources
#4. Working Capital Using an Invoice Factoring Service
Average Annual Interest Rate: 40-60%
Invoice factoring is when a business sells future payments based on outstanding invoices to an invoice factoring service that gives them immediate cash. Basically, instead of having to wait to collect on future invoices, invoice factoring allows a business to get capital right away. When those invoices come due, the invoice factoring service collects the payments directly from the invoiced business.
Invoice factoring is a quick and flexible way to get short-term capital and bridge cash flow gaps. You can select which accounts/invoices you want to factor. To qualify, you should have recurring invoice customers who pay their invoices promptly. Also, it is best to only factor invoices that are due in the next 2 to 10 weeks. If the invoice due date goes past 90 days and the invoice factoring company has not received their money, they have the right to sell the invoice back to you, which can be a big problem if you have already spent the money.
Pros of Using Invoice Factoring
- Lowest interest of the short term lending options (i.e. merchant cash advance, alternative lenders)
- Can get money fast
- Don’t need collateral
- Only available to companies that use an invoicing system/software
- Have to go through the hassle of telling your customers that they have to pay the invoice factoring company
- Higher interest than longer-term lending solutions
- Still need pretty good credit (600 or above)
- Have to have customers who have been reliably paying their invoices for at least a year
Invoice Factoring Resources
For more information about invoice factoring, check out our article on How Invoice Factoring Works.
#5. Working Capital from Alternative Lenders
Average Annual Interest Rate: 40-80%
Alternative Lenders are basically non-bank lending companies that provide short-term (3 months-2 years) loans to businesses with lower credit scores. To qualify, you need to have been operating for at least a year, but you can qualify with a lower credit score (500 or above). Alternative lenders are also much more willing than banks to give loans that are under $100,000.
If you need a small loan that you are going to be able to pay off within a year or two, then alternative lenders can be a great option. Just be mindful that they are costlier than a traditional commercial loan or SBA loan. In addition, if you want more money and a longer term, then you should probably look into other options.
In addition to a personal guarantee, many alternative lenders will also place a lien on your business assets. This is similar to collateral. If you cannot repay the loan, the lender can sell off your business assets to satisfy the loan. The personal guarantee means you’re on the hook for the loan even if your business closes down, and your personal credit score may be affected if you make late payments or don’t pay back the loan.
Pros of Getting Money from an Alternative Lender
- Can get a short term loan (1-2 years)
- Don’t need as good credit as you do for a commercial loan, SBA loan, or P2P loan
- Get your money faster than a traditional commercial loan or SBA loan
- Can sometimes get approved after only one year of business operation
Cons of Getting Money from an Alternative Lender
- Interest much higher than SBA loans and traditional commercial loans (double, triple or even more)
- Requires a personal guarantee.
- Requires a lien, which is similar to collateral.
Read our guide to the best short term lenders.
#6. Working Capital Through A Merchant Cash Advance
Average Annual Interest Rate: 60+% (often effectively 80% or higher)
A merchant cash advance is when a business gets money from a company that provides lump-sum loans based on the annual credit card receipts of a business. Personal credit and collateral do not matter that much. It’s all about how much credit and debit card revenue your business makes in a year.
The nice thing is that this form of financing relates to your business only; there is no personal guarantee of payment, and if you cannot pay, your personal credit score will not be damaged. However, there is a downside: the killer interest, which is generally 60% or higher annually. There is no fixed time period for merchant cash advance payback because you do not have to pay if your credit card sales dry up. You just resume payments when they start flowing again. In general, most companies pay back a merchant cash advance within 4-18 months.
Pros of Getting Money Using a Merchant Cash Advance
- Can be accepted with a bad credit score
- You don’t need any collateral other than a consistent credit card business.
- No personal guarantee needed
- Fast way to get money
- You only pay in proportion to your credit card receipts. If you have a bad month, payments are lower. If you make no sales for some time, you resume payments when sales start coming ie again.
Cons of Getting Money Using a Merchant Cash Advance
- Extremely, extremely high interest rate
- Can only get money if you have lots of credit card sales
Merchant Cash Advance Resources
- Read Our Full Guide To Merchant Cash Advances
- Apply For A Merchant Cash Advance With Our Recommended Provider
The good news is that there are lots of ways to raise working capital for an existing business. The bad news is that you will probably be stuck paying a high interest rate if you do not have good credit or significant collateral. We encourage you to check out our in-depth articles at the bottom of each financing option above so that you do not miss important information and can figure out which source of financing is best for your business.