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Updated: Feb 6, 2020
Working capital is a vital resource for small business owners and if you’re running low on cash, being able to borrow money quickly is a must. When you need to beef up your business’s inventory, a term loan may be the best solution.
A term loan is similar to a mortgage or car loan, in that it has a fixed repayment schedule. This type of loan offers convenient funding and the interest and fees are usually more attractive than an alternative like a merchant cash advance.
After you’ve finished reading this guide, you’ll understand:
Inventory financing is a type of short-term borrowing option that business owners use to purchase inventory. Typically, the inventory you buy and/or any existing inventory the business has serves as collateral for the loan. If you end up in default, those assets would be turned over to the lender in lieu of payment.
Term loans can feature shorter or longer payoff periods but when they’re used for inventory purchases, a shorter term is the norm. Depending on the lender, terms range from three months to three years.
The annual percentage rate (APR) can be fixed or variable and it’s possible to borrow up to 100% of the inventory’s value. In terms of a dollar amount range, term loans may start as low as $20,000 and go up to $1 million, based on which lender you choose.
As the name suggests, inventory financing is suited to businesses that sell a tangible product. If your business is purely service-based, an inventory loan wouldn’t be a viable option for meeting your cash flow needs because you have no physical product to speak of. You could still fund your business with a term loan but you’d need to offer up other personal or business assets as collateral.
Retail stores, wholesalers and specialty shops are all examples of businesses that could use inventory financing to keep their shelves stocked. Inventory loans are also useful for seasonal businesses that see their cash reserves drop during slower times. Individual lenders can cater to certain types of businesses but generally, your ability to qualify for financing depends more on your business’s track record than what you sell.
For that reason, inventory financing is targeted towards businesses that have a history of purchasing inventory. If your business is a startup that’s buying inventory for the first time or has yet to complete its first sale, something like a business credit card or a small business startup loan would likely be a better fit.
Deciding whether a term loan makes the most sense when you need to purchase inventory depends on a few different factors. For example, a term loan might be appropriate if:
The advantages of using a term loan to get the inventory you need are many. For starters, funding is relatively quick and it’s possible to have the money deposited into your bank account within a matter of days. That’s extremely important for businesses that don’t have weeks to wait around to purchase inventory.
If you’re using an online lender versus a traditional bank, you’re likely to run into fewer obstacles during the application process. That’s a definite plus if you’re trying to grow your business but other financing doors have been closed to you. You might also have more flexibility in negotiating repayment terms that fit with your business’s budget.
Before you pull the trigger, however, there are a few potential downsides to keep in mind. Business owners should pay attention to three specific things prior to signing off on an inventory loan.
Inventory loans are by nature a riskier bet for lenders because they’re banking on your ability to sell all of the inventory you’re purchasing. As a result, the APR for this kind of loan may be at the higher end of the scale, especially if you choose a shorter repayment term. It’s important to weigh the cost of the interest against the convenience of the loan and the profits you anticipate making off the inventory to determine whether it’s worth the cost.
Aside from the APR, business owners must also factor in the fees associated with a term loan. For instance, it’s not uncommon to pay an origination fee in the neighborhood of 2% to 5%. Again, those additional costs must be considered if you’re comparing a term loan to other inventory financing methods.
Inventory loans require collateral but lenders can also impose another check on your promise to repay–the personal guarantee. A personal guarantee effectively makes you personally liable if your business defaults on an inventory loan. So not only is the lender able to lay claim to your inventory, they could also sue you to attach your personal assets. A personal guarantee is almost always unavoidable with a term loan but you should be clear about what it involves.
If you’re certain that a term loan is the best way to pay for inventory purchases, you shouldn’t let the fact that you’re pressed for time paint you into a corner. Here are a few things you should do as you’re preparing to apply for inventory financing:
To learn more about what the application process entails, take a look at this detailed guide to getting a term loan.
Michael Jones is a Senior Editor for Funding Circle, specializing in small business loans. He holds a degree in International Business and Economics from Boston University's Questrom School of Business. Prior to Funding Circle, Michael was the Head of Content for Bond Street, a venture-backed FinTech company specializing in small business loans. He has written extensively about small business loans, entrepreneurship, and marketing.