Working capital loans: the flexible funding solution for startups and SMBs

Ever faced a cash crunch while waiting for invoices to clear or sales to pick up? Working capital loans are a lifeline for startups and small businesses navigating these gaps, covering everything from payroll to inventory. 

Whether you’re a seasonal retailer stocking up for the holidays or a SaaS startup bridging a client payment delay, this guide breaks down how these loans work, the best options for your needs, and how to avoid common pitfalls. Let’s dive in.

What are working capital loans?

Working capital loans are short-term financing options designed to cover day-to-day business expenses like payroll, inventory, and rent. 

Unlike long-term loans for equipment or real estate, these loans focus on keeping your operations running smoothly during cash flow gaps. 

For example, a retail store might use one to stock up before the holiday season, while a SaaS startup could bridge the gap between client payments.

Why startups and small businesses need working capital

If you’re wondering whether you’ll need working capital loans at some point, the answer is likely yes. Cash flow is the lifeblood of any business, but uneven revenue cycles are common—especially for startups and seasonal businesses. 

Seasonal demand spikes during holiday periods, delayed client payments, or all kinds of unexpected expenses can derail your business and affect your financial health.

In other words, working capital loans help you:

• Pay suppliers or employees during slow months.
• Seize growth opportunities (e.g., bulk inventory discounts).
• Handle emergencies (e.g., equipment repairs, client payment delays).

5 common types of working capital loans

Not all loans are created equal. Here’s a breakdown of the most common options and their nuances:

1. Short-term business loans

Short-term business loans are designed to help businesses address immediate, one-time financial needs. 

They are often used to cover unexpected expenses, such as payroll during a slow month or other urgent costs that require quick access to capital.

These loans offer fast funding but come with relatively short repayment terms. Note that some lenders may also charge prepayment penalties if you pay off the loan early.

• Best for: Immediate, one-time needs (e.g., covering payroll during a slow month).
• Terms: Repaid over 3–24 months.
• Rates: 8%–36% APR, depending on creditworthiness.
• Additional considerations: Some lenders charge prepayment penalties if you pay off the loan early.

2. Business lines of credit

A business line of credit offers flexible, revolving access to funds, making it perfect for businesses with ongoing or unpredictable expenses. 

With this type of financing, businesses can borrow up to a certain limit, repay, and reuse the funds as needed, which helps in managing cash flow gaps. It’s ideal for companies that have fluctuating financial demands and need access to funds on an ongoing basis.

• Best for: Ongoing or unpredictable expenses (e.g., a contractor buying materials for multiple projects).
• Terms: Borrow up to a limit, repay, and reuse funds.
• Rates: 10%–25% APR.
• Additional considerations: : Unused credit lines may have annual fees

3. SBA Working Capital Loans (SBA 7(a))

SBA 7(a) loans are a government-backed financing option designed for well-established businesses. 

These loans offer competitive rates and long repayment terms, making them ideal for businesses that need capital for operational costs, expansion, or purchasing equipment. 

They are often a great choice for businesses with a strong credit history and a few years of operations under their belt.

• Best for: Established businesses with strong credit (2+ years in operation).
• Terms: Up to $5 million, 5–10-year repayment.
• Rates: 8%–13% APR.
• Additional considerations: The SBA requires collateral for loans over $25,000.

4. Invoice financing

Invoice financing is an excellent solution for businesses that are facing delayed payments from clients. It allows businesses to borrow a percentage of the value of their outstanding invoices, which can help improve cash flow without having to wait for clients to pay. 

This type of financing is particularly useful for B2B businesses that have unpaid invoices but need immediate capital to keep operations running smoothly.

• Best for: B2B companies with unpaid invoices.
• Terms: Borrow 80%–90% of an invoice’s value; repay when the client pays.
• Rates: 1%–5% monthly fee.
• Additional considerations: Some lenders charge additional fees if the client pays late.

5. Merchant Cash Advances (MCAs)

Merchant Cash Advances are designed for businesses that rely heavily on credit card sales, such as restaurants or retail stores. MCAs provide businesses with a lump sum upfront, and repayment is based on a percentage of daily sales. 

While this offers flexibility, it can be a costly option, as the factor rates can lead to extremely high annual percentage rates (APRs), making it a riskier option for businesses with fluctuating revenues.

• Best for: Businesses with high credit card sales (e.g., restaurants).
• Terms: Repay via a percentage of daily sales.
• Rates: Equivalent to 40%–350% APR due to high factor rates.
• Additional considerations: MCAs can trap businesses in a cycle of debt if sales slump.

How to qualify for a working capital loan? 3 factors lenders evaluate

While traditional banks prioritize established businesses (think 2+ years in operation), online lenders cater to startups and companies with shorter track records. These lenders evaluate three key factors: your creditworthiness, cash flow stability, and business history. 

Understanding these levers helps you target the right lenders and avoid wasted applications, so let’s break them down.

1. Credit scores

Your personal and business credit scores signal risk to lenders. 

Banks typically require a FICO score of 680+ for competitive rates, but online lenders may accept scores as low as 600. 

For businesses with poor credit (below 600), your options narrow down to:

• Secured loans (using inventory or equipment as collateral).
• Merchant cash advances (high-cost, but approval hinges on sales volume, not credit).

If you happen to fall into that latter bucket, some fintech lenders now weigh cash flow metrics (e.g., monthly deposits) more heavily than credit scores.

2. Revenue requirements, i.e. proving you can repay

Most lenders require $50,000–$100,000+ in annual revenue. 

However, startups without a financial history can substitute:

• Signed client contracts or purchase orders.
• Projections backed by market research (for revenue-based financing).

Note that if you’re a seasonal business, you could face extra scrutiny. A surf shop, for example, might qualify by averaging its high-season revenue over 12 months.

3. Time in business

Age matters here. The longer, the better, especially for banks and credit unions that often demand 2+ years of operation. 

Online lenders are more lenient, sometimes approving businesses as young as 6 months. Startups under 6 months have limited options, like personal loans tied to the owner’s credit.

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Ultimately, is a working capital loan right for you?

To sum it all up, these loans are best for short-term cash flow gaps, but they aren't always the right solution.

Consider a working capital loan if:

• You’re facing a short-term cash gap due to seasonal fluctuations or unexpected expenses.
• You need funds quickly, typically within a week, for urgent costs like payroll or inventory.
• You can repay within 1–2 years without straining your business’s cash flow.

Avoid a working capital loan if:

• You’re trying to cover long-term financial issues—loans won’t fix structural problems in your business model.
• You’re already over-leveraged with a debt-to-income ratio over 40%, as adding more debt could put your business at risk.

By weighing these factors, you can determine whether a working capital loan is the right choice for your business.

Working capital loan alternatives to avoid the debt trap

When cash flow gaps arise, businesses often seek quick fixes, but it’s so crucial to understand the potential risks of certain loan terms, such as prepayment penalties, personal guarantees, and complex APR structures. 

For instance, a bakery might face a 5% penalty for repaying a $20,000 loan early, or a small business could risk personal assets like their home if they default on a loan that requires a personal guarantee. 

Similarly, a merchant cash advance with a 1.3 factor rate can end up costing a business $65,000 instead of $50,000, even if repaid within a few months.

Fortunately, there are alternatives that may better suit your needs without the added risks.

• Negotiate extended payment terms: Reach out to suppliers and discuss longer payment windows, such as Net 60 or Net 90-day terms. This can help tide you through busy holiday sales seasons or peak periods.
• Explore revenue-based financing: This option links repayments directly to your business’s revenue. It’s ideal for businesses with fluctuating income, like marketing agencies or seasonal businesses, where payments adjust as sales rise or fall.
• Try Rho’s corporate credit cards: For short-term financing needs, Rho’s corporate credit cards offer flexible payment terms and seamless integration with your financial tools. You can use them to cover cash flow gaps, such as payroll or waiting for client payments, while maintaining better control over your expenses and avoiding high-interest debt.

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How Rho simplifies access to working capital

If you're looking for flexible financial solutions that help manage cash flow without the burden of traditional loans, Rho offers a variety of tools to help streamline your operations. 

From business accounts to corporate credit cards, Rho enables you to manage expenses, optimize cash flow, and focus on growth—all from one platform.

With Rho, you can:

• Manage cash flow efficiently with business checking and savings accounts.
• Leverage corporate credit cards to cover short-term expenses like payroll or vendor payments, with flexible payment terms and no hidden fees.
• Integrate seamlessly with your existing financial tools to track and control expenses in real time.
• Automate expense management and accounts payable to reduce administrative overhead and ensure timely payments.

Explore Rho’s comprehensive solutions today to keep your business moving forward, even when cash flow stalls.

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