Companies live and die by their access to capital. The U.S. Chamber of Commerce lists “Cash Flow Problems” as the #1 reason small businesses fail. Whether it’s a real estate investment, a brick-and-mortar business, or a digital enterprise, when those inevitable cash-flow slumps occur, access to working capital is nothing short of a lifeline. For newer businesses, cash flow has a nasty habit of not kicking in exactly on schedule. In the initial or startup phase, access to working capital can make the difference between breaking through or going bust.

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Bottom line — nearly every business will need to borrow money at some point to access the working capital it needs. The entire global architecture of business and commerce depends on it. If it’s time for your business to borrow working capital, you will inevitably face a choice — working capital loan vs. line of credit. Both are viable ways to borrow … So which one is the best choice for your business at this time?

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Let’s compare and contrast working capital loans and working capital lines of credit — what makes them the same, what makes them different, what makes them the right choice for different scenarios you might find yourself in as an entrepreneur — and how Munoz Ghezlan Capital can help with small business funding, real estate credit, and more.

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What Is a Working Capital Loan?

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A working capital loan fits the picture that pops into most peoples’ minds when they think of a “business loan.” It’s a lump-sum loan where you receive the entire loan balance upfront. The cash goes into your company bank account, and it’s yours to spend on business expenses as you see fit.

You can use the proceeds of a business loan to:

• Fund your payroll.
• Pay rent on your office or retail space.
• Stock inventory.
• Pay contract and subscription fees.
• Pay utility bills.
• Pay property, merchant, or franchise taxes.

Characteristics of a Working Capital Loan

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A working capital loan has a fixed amount. If your borrowing power is $1 million, $1 million gets wired to your bank account. 

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Whatever the amount, you will be required to repay the loan over a fixed period. Most business loans are fully amortized, meaning by the end of the term the payments will have returned the entire principal. However, some working capital loans (e.g. bridge loans, merchant cash advance) may not be fully amortized. If not, a balloon payment of the remaining principal balance may be required if the loan is carried all the way to the end of the term.

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Most short-term working capital loans have fixed interest rates. Longer-term loans often have a fixed-interest-rate period and then variable rates after the fixed interest period where the interest rate is pegged to an index like the prime rate or SOFR.

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Working capital loans are usually unsecured, meaning you put up no collateral — no specific asset (real estate, business property, personal property, vehicles, etc.) are automatically at risk of confiscation in the event of default. However, you may be required to agree to personal guarantees of repayment, meaning your personal or business assets may be subject to seizure in the event of default if the creditor can find and target them in a lawsuit.

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Real estate companies usually depend on commercial mortgage debt to acquire properties, secured by the property as collateral. However, established real estate companies with good real estate credit can still access unsecured working capital loans to help them scale.

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Common Uses of Working Capital Loans

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Working capital loans for enterprise and small business funding are often used to:

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• Cover seasonal gaps in cash flow.
• Fund unexpected expenses.
• Finance initiatives for short-term growth — for example, a product launch or marketing push.

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Types of Working Capital Loans

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• Term Loans. These loans are lump-sum loans that get repaid with monthly principal-plus-interest payments over a fixed term. You can get them from banks, credit unions, or online lenders. Working capital term loans are usually based on your business cash flow, personal credit history, business credit history, revenue consistency, and personal guaranties or a Uniform Commercial Code (UCC) lien on the borrower’s assets.

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• SBA Loans. An SBA loan is a type of term loan that is fully or partially guaranteed by the U.S. Small Business Administration (SBA). With this extra guarantee, lenders who offer them can typically furnish lower interest rates and longer terms, though a down payment may be required.

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• Merchant Cash Advance. If you have a merchant account for credit card processing, you can borrow against the payouts from your merchant account, usually a short-term loan at higher interest rates.

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• Invoice Financing. Some lenders offer loans based on unpaid invoices. The loan treats the invoice as an “account collectible,” a kind of asset, with the assumption that you will eventually collect on the invoice.

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Working Capital Loans – Pros & Cons

Pros

• Predictable repayment schedule helps you plan your future cash flow.
• Fast funding gets you the capital when you need it, even on short notice.
• No need to reapply — once it’s done, it’s done. 

Cons

• Once the funds are disbursed, you can’t get more. If you need more capital, you would need to apply for another loan.
• Shorter term loans may carry higher interest rates.
• Longer-term loans may include variable interest rates, making it harder to predict your cash flow.

What Is a Working Capital Line of Credit?

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Whereas a working capital loan is a lump-sum loan with fixed payment terms, a business line of credit is a type of revolving credit line. It functions similarly to a credit card. The lender issues you a set credit limit. At any given time you could have no balance outstanding against the credit limit; or you could borrow up to the entire credit limit; or anything in between.

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If you have no balance, you owe no payments and incur no interest. However, if you carry a balance on your line of credit, interest will accrue against that carried balance (and only that balance, not the entire credit limit) and you will owe payments against that balance according to the terms of the loan.

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Characteristics of a Working Capital Line of Credit

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Unlike credit cards, which usually stay open until you close them, working capital lines of credits usually have a set expiration term. However much you do or don’t draw against the line of credit, at the end of the expiration term your lender can either choose to renew the line of credit or cancel the line of credit and call due any outstanding balance. The most common expiration/renewal review term is 12 months, but more established companies with strong credit may qualify for 2-3 year expiration/renewal periods.

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Working capital lines of credit usually have variable interest rates pegged to indices like the prime rate or SOFR. Payments are usually interest-only with discretionary payment of principal, but principal balances will continue to accrue interest for as long as you carry them. 

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Additionally, many working capital lines of credit have a “cleanup clause” that requires you to reduce the balance to zero for a period of the term (e.g. 30 consecutive days) to verify that you are using the line of credit for working capital instead of long-term borrowing. They may also include extra fees like maintenance fees, draw fees, and inactivity fees.

Common Uses of Working Capital Lines of Credit

Working capital lines of credit are often used for:

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• Management of unpredictable cash flow.
• Covering for delayed client payments.
• Funding recurring expenses without overborrowing.

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Types of Working Capital Lines of Credit

• Unsecured Line of Credit. These working capital lines of credit require you to put up no assets as collateral. Approval is based on creditworthiness and the performance of your business. Because they are unsecured they usually have higher interest rates, smaller credit limits (~$25k-$250k), and the lender — usually a bank, credit union, or online lender — may require a personal guarantee and/or a UCC lien.

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• Secured Line of Credit. Some lines of credit can be secured by assets like invoices, accounts receivable, or equipment. Common for distributors, wholesalers, and manufacturers, the lender may set a credit limit like 50-60% of inventory value or 80-90% of accounts receivable value, with the assets as collateral. Because of the collateral, interest rates tend to be lower, balances higher.

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• SBA CAPLine. In addition to working capital loans, the SBA also insures lines of credit up to 75%85% of the credit limit. Credit limits can go as high as $5 million, with lower interest rates, annual renewal periods, and cleanup clauses.

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• Business Credit Cards. Business credit cards offer another source of revolving debt that can be used for small business funding as well as enterprise financing. Small business cards can be acquired with relative ease, some of them with zero-interest welcome periods. Enterprise-level corporate cards can also be acquired with higher limits.

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Working Capital Lines of Credit – Pros & Cons

Pros

• Flexibility in how much capital you can access up to the line of credit.
• You only owe interest on funds you actually use.
• You can use the line of credit as many times as you want (up to the line of credit) during the term of access.

Cons

• Variable interest rates make cash flow hard to predict.
• Revolving lines of credit carry the risk of overuse.
• Borrowers must submit to periodic renewal reviews.

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Working Capital Loans vs. Lines of Credit – Key Difference

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Structure and Access

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Working Capital Loan: Lump sum received as a single disbursement.

Working Capital Line of Credit: Revolving access you can draw upon as needed.

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Cost of Borrowing

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Working Capital Loan: Fixed interest rates, fixed term.

Working Capital Line of Credit: Variable interest, potential fees.

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Flexibility of Repayment

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Working Capital Loan: Predictable monthly payments.

Working Capital Line of Credit: Adaptable, but harder to predict cash flow.

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Approval Requirements

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Working Capital Loan: Underwritten based on credit history/score, age of the business, and revenue.

Working Capital Line of Credit: Strict underwriting for unsecured lines of credit; annual renewal reviews.

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Business Use Cases

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Working Capital Loan: One-time expenses, planned short-term projects.

Working Capital Line of Credit: Ongoing operational flexibility.

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Risks and Discipline

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Working Capital Loan: Fixed repayment schedule imposes financial discipline.

Working Capital Line of Credit: Flexibility carries with it risk of dependence and overborrowing.

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Which Is Right for You — Working Capital Loan vs. Line of Credit

Here are some guidelines to consider when deciding which working capital financing structure is better suited to your needs:

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What Does Your Business Need?

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If you have predictable cash flow, a working capital loan might be the best choice due to your ability to build the predictable repayment structure into your cash flow projections.

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If your cash flow fluctuates, a secured or unsecured line of credit might be more appropriate. You can draw on it when cash flow is lean, and leave the balance at zero when your cash flow is flush.

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If you have a one-time need for funding, a working capital loan might be the most appropriate vehicle to finance that need.

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If you have ongoing funding needs, a working capital line of credit gives you the flexibility to fund those needs.

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What Is Your Cost and Risk Tolerance?

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If you want a fixed interest rate and predictable cost of borrowing, a working capital loan is more suitable.

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If you’re comfortable with variable interest rates and fluctuating costs of borrowing, you will probably be happy with a working capital line of credit. 

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If you are uncomfortable with a less-structured repayment plan and want some built-in financial discipline, a working capital loan is the way to go.

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If you trust your company to borrow responsibly and scrupulously manage a more freewheeling payment structure, you can consider a working capital line of credit.

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What Application and Renewal Process Are You Comfortable With?

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If you only want to clear a one-time hurdle of underwriting and approval, you want a working capital loan.

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If, on the other hand, you’re comfortable with a rigorous approval process followed by annual reviews to maintain your borrowing power, you might be a good candidate for a working capital line of credit.

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Example Use Cases

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Working Capital Loan

A retailer with predictable cash flow who needs to stock extra inventory for the holiday season might benefit from a working capital loan. It’s a once-a-year expenditure with a reasonable assumption of a seasonal spike in revenue to justify taking on a one-time debt burden.

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Working Capital Line of Credit

A service business with inconsistency in client payments might benefit from the safety net of a working capital line of credit or absorb unpredictable expenses, especially if they have invoices to act as collateral.

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What About a Hybrid Strategy?

A creditworth business doesn’t necessarily have to feel backed into an “either/or” decision. Many businesses adopt a “hybrid” strategy that includes both working capital loans and working capital lines of credit. The working capital loans act as upfront capital, while the lines of credit help preserve their long-term liquidity.

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How to Apply:

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Working Capital Loan

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To apply for a working capital loan, you will need to furnish your prospective lender with your financial statements (usually two years), tax returns (usually two years), and a business plan that includes the use of the requested capital. Approval and funding can take anywhere from a few days to several weeks.

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Working Capital Line of Credit

Applying for a working capital line of credit usually requires similar documentation to a working capital loan, but with extra focus on the creditworthiness of your business, cash flow stability, and availability of collateral. Approval and funding time also ranges from a few days to several weeks.

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Tips To Improve your Chances of Approval

• Keep your financial records clean, clear, and accessible.
• Focus on building your business and personal credit before you apply.
• Use accounting tools to improve your cash flow visibility.

Bottom Line

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Working Capital Loans and Working Capital Lines of Credit are both valid resources for companies to leverage to grow, weather lean seasons, and prosper. 

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For companies on the verge of a major growth sprint or facing a major one-time expense, a working capital loan gives them a financial lifeline with favorable rates, built-in discipline, and predictable repayment terms for easy cash flow management.

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For companies with variable cash flow, ongoing capital needs, and financial discipline, a secured or unsecured line of credit offers flexibility, a cash safety net, and the opportunity to leverage non-cash assets as collateral for periodic cash injections.

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If you’re still trying to decide between a working capital loan vs. line of credit, a Munoz Ghezlan Capital strategist can not only help you zero in on the right type of financing for you, but also help you dial in your real estate credit, business credit, or other credit ratings, and connect you with lenders who are eager to finance a business like yours into a lucrative legacy. Schedule your complimentary strategy session today to get the funding you need to flourish.