Working capital loan vs. small business loan

Many types of funding are available for small businesses that need to borrow money, including working capital loans and small business term loans. These two types of loans are widely used by businesses but for different purposes.

A working capital loan provides fast funding to pay for day-to-day operating costs, while a small business term loan is typically used for significant, one-time expenses. This is just one of the ways the two loan types differ. Repayment terms, interest rates and other elements also vary.

If you’re considering a loan for your small business, you aren’t alone. Aside from credit cards, loans are the most common form of funding used by small business owners, with 50 percent relying regularly on loans, according to the 2024 Small Business Credit Survey. Understanding the options, including the difference between a working capital loan and a small business loan, can help you identify the most appropriate type of funding for your business.

What’s a working capital vs. small business term loan?

Working capital loans are a type of small business loan, typically with short repayment terms such as two years or less. Like any business loan, they can be a lump sum of cash or a revolving pool of cash you draw from as needed. What makes them different from a small business term loan is that they cover day-to-day costs rather than funding a large, one-time purchase.

A small business term loan, on the other hand, covers purchases that can’t be repaid quickly. This may include equipment, investments and expenses that cover growth and expansion costs and need to be paid off over terms of three to five years or longer.

What can you use working capital loans for?

The best working capital loans can be used for various operating costs. Some of the ways the money can be used include:

• Emergencies
• Payroll
• Utilities
• Rent
• Inventory purchases
• Pay short-term debt
• Marketing
• Supplies
• Paying vendors
• Cover short-term cash flow gaps

Types of working capital loans vs. small business term loans

Within the working capital loan and term loan categories, there are several borrowing options.

Alternatives to working capital loans

Working capital loans may not be the right choice for every business. Instead, you might look into alternatives, including:

• Long-term business loans: These loans involve a longer repayment timeline, typically five years, though some lenders may offer terms of 10 years or longer. You might need a long-term loan if you’re making a large purchase and need to keep the business loan repayments manageable.
• Grants: Depending on the type of business, you may be able to access grants from the local, state or federal government. You won’t need to repay the grant, though the grant organization may require you to pitch your business and show how you plan to use the funds. Often this type of funding targets economically disadvantaged businesses, minority-owned, veteran-owned or women-owned businesses.

Where to get a working capital loan

You can apply for a working capital loan with various lenders, including banks, credit unions and online lenders.

Traditional banks often offer the most appealing interest rates, though they may have strict criteria to be eligible for a business loan.

Online lenders can typically fund loans much faster than banks, but you may trade high interest rates for the fast funding and relaxed eligibility requirements.

Credit lines and term loan amounts vary significantly based on the lender and their eligibility requirements. Some lenders may also require you to have a business checking account.

Pros and cons of term loans vs. working capital loans

As with any type of borrowing, there are benefits and drawbacks to consider.

Pros and cons of term loans

Pros

• Widely available, including from banks and credit unions
• Provides a lump sum of money upfront
• Longer repayment terms

Cons

• Interest may be higher for small businesses or start-ups
• May have higher revenue requirements
• Secured term loans require collateral
• Application and approval process may be lengthy

Pros and cons of working capital loans

Pros

• Funds can be used for anything
• No collateral required
• Funding available quickly, sometimes same day

Cons

• Short repayment terms
• Higher interest rate than other loans
• Smaller loan amounts

Are working capital loans or small business term loans better?

Deciding whether a working capital or small business loan is better really depends on your business’ goals and needs. A working capital loan may be more expensive due to higher interest rates and fees associated with the loan. However, these types of loans can be a good choice if you need funding quickly and are looking for a source of funding that you can continue to access as needs arise, rather than a one-time lump sum of money.

A small business term loan, on the other hand, may be the best choice if your business is seeking a significant amount of money to purchase new equipment or fund an expansion or some other type of significant one-time expense. Term loans often have lower interest rates and longer repayment terms, which can make them more attractive. However, they also come with a comprehensive application process and often have higher revenue requirements for approval.

Bottom line

Working capital loans can provide access to cash to help cover various short-term expenses, including wages, debt, rent and utilities. Even startups or business owners with low credit scores can qualify for a working capital loan. If you’re considering this type of loan, investigate the options and find the right loan for your business’s unique needs. Key to managing your working capital loan is understanding where the money will most aid your business and plugging the loan repayment into your business budget.

Frequently asked questions

• Can SBA loans be used for working capital?

  Some SBA loans can be used for working capital but not all of them. SBA Express loans, microloans and 7(a) loans can be used to cover working capital needs.

• Who should use a working capital loan?

  Working capital loans should be used by businesses that need to cover short-term needs. This includes expenses such as payroll, rent, debt payments and utilities. You will want a solid plan to help you manage the business loan, such as adding the repayments as a line item in your budget.

• Can you get a working capital loan or a term loan from the same type of lender?

  Yes, some lenders may offer both types of loans. For instance, you can typically apply for a working capital loan from banks, credit unions and online lenders. Similarly, banks, credit unions and online lenders also offer term loans.