How Short-Term Financing Can Give Small Businesses the Edge
Company owners don’t always need long-term financing repayable over multiple years to meet their business needs and financial obligations. Sometimes, short-term financing can be enough to get them over a temporary liquidity crunch.
Below, find out what short-term financing is, what five of the most common types of short-term financing options are, and how to choose the right option for your business.
What Is Short-Term Financing?
Short-term financing is a loan or other credit facility — like a business line of credit or invoice factoring — that borrowers pay off quickly, often within a period of 24 months or less.
Businesses often access short-term funds from commercial banks, credit unions, brokers, and online lenders to:
Manage seasonal or interrupted cash flow
Purchase equipment
Buy inventory
Take advantage of a business opportunity
Meet sudden and unexpected emergency expenses
Short-Term vs. Long-Term Business Financing
Many companies prefer short-term business loans and other types of financing because repayment terms are often more flexible, the overall interest paid is lower (even if interest rates are higher), and turnaround times between applying and receiving the funds can be faster.
Shorter repayment periods can present challenges, however.
Higher repayments can put significant pressure on your cash flow. As your repayments are higher, you are at more risk of missing or having to delay payments, which will affect your credit score. Additionally, you may need to refinance a facility if you’re unable to settle it in full because you fail to hit projections.
5 Different Types of Short-Term Financing for Companies
There are many different types of short-term financing for businesses. Below, we cover five of the most popular, describing what each is, their standard lender eligibility criteria, and their pros and cons.
1. Business Lines of Credit
A business line of credit is a form of revolving credit. It bears many similarities to a business credit card.
You can borrow any amount of money up to the limit set by your provider, and you only pay interest on the capital you actually withdraw. When you pay some or all of your balance down, you can borrow that money all over again.
Companies use this flexible form of financing for a variety of reasons like covering unexpected costs, managing cash flow during slower periods, and buying inventory.
Business Line of Credit Advantages
Greater flexibility: You draw down capital only as you need it and only pay interest on the outstanding balance.
On-demand availability: You can borrow, repay, and borrow again from your facility without needing to reapply each time.
Quick turnaround: The application process is usually no more than a few days, ideal for emergency situations.
Business Line of Credit Disadvantages
Variable interest rates: If your business line of credit has a variable interest rate and the Fed raises rates, you may pay more.
Higher fees: Some business lines of credit come with maintenance or draw fees, which push up your account costs.
Reducing limits: Lenders can reduce your credit limit unexpectedly, which can impact your cash flow management.
2. Bridge Loans
A bridge loan is a short-term secured loan that allows you to cover your company’s temporary financial needs until you can obtain long-term financing — it “bridges” the gap.
You get a lump sum of money upfront to, for example, purchase and renovate a commercial property you want to move into. Your “exit strategy” in this case might be to secure a commercial mortgage on the renovated property when the project is completed, which you use to pay off the bridge loan.
Bridge loans are also useful in other situations like covering cash shortfalls when waiting for an invoice to arrive and in mergers and acquisitions.
Bridge Loan Advantages
Lender flexibility: Lenders will fund complex, higher-risk projects that other financial providers would not consider.
No monthly installments: In most cases, you repay the loan in full on the completion of the project, which preserves your cash flow.
Fast approval: Loans can be approved in a very short period of time, allowing you to take advantage of transient, “act-now” opportunities.
Bridge Loan Disadvantages
High interest rates: Bridge lenders charge higher interest rates than on long-term loans because of the increased risk.
Expensive fees: Non-interest-related charges like appraisal, origination, legal, and notary fees quickly add up.
Refinancing risks: You may be forced to take out another bridge loan to pay an existing one-off if your exit strategy is delayed.
3. Merchant Cash Advances
With a merchant cash advance (MCA), lenders advance you an agreed loan amount based on your historic credit and debit card sale turnover.
There are no monthly payments with this type of small business loan. Instead, a percentage of your daily credit and debit card settlement is taken automatically every day until you clear the balance.
Merchant cash lenders charge you a factor on the size of the facility you borrow. For example, with a factor rate of 1.3, if you receive a $10,000 advance, you will repay $13,000.
Merchant cash advances are a popular form of short-term financing for companies buying equipment, stocking up on inventory, or seeking to manage short-term cash flow fluctuations.
Merchant Cash Advance Advantages
Unsecured loans: Many merchant cash advance providers don’t require business owners to provide collateral.
Bad credit histories accepted: MCAs are popular and business owners with poor credit scores as well as startups because application approval rates are high.
Variable repayments: You pay less when sales are lower, helping to preserve cash flow during quieter times.
Merchant Cash Advance Disadvantages
Very expensive: Factor rates are very high, meaning that you may pay substantially more for the facility compared to other financing options.
Cash flow pressures: Cash may drain quickly from your company’s bank account if you operate at a lower profit margin.
Potential debt spiral: The pressure on cash flow may lead to businesses taking out further advances, creating a cycle of debt.
4. Invoice Factoring
Invoice factoring is a way for businesses to raise funds by selling their unpaid invoices, sometimes called accounts receivables.
The factorer advances you 70%-90% of the invoice amount upfront and then pays the rest, minus their fee after the customer pays. You can ask the factorer to chase your invoices, or you can chase them yourself.
There are two different types of invoice factoring:
Recourse factoring: If your customer does not pay the invoice, you have to reimburse what your factorer has advanced you to date.
Non-recourse factoring: Your factorer will not claw back advances on unpaid invoices; however, they charge you an additional fee for this.
Invoice factoring is useful for improving cash flow for operational expenses like payroll, rent, or supplies. It can also help businesses manage growth and handle seasonal fluctuations in sales.
Invoice Factoring Advantages
Improved cash flow: Invoice factoring provides immediate cash to businesses, making it easy to manage cash flow.
Better financial ratios: Invoice factoring doesn’t add debt to your business’s balance sheet, which can make your business more attractive to investors and other lenders.
Competitive advantage: You can give customers windows of 30, 60, or 90 days to pay while your competitors might require payment in advance.
Invoice Factoring Disadvantages
Outsourcing credit control: You’re reliant on your factorer’s skill at chasing invoices, which some struggle with, according to many online reviews.
Onerous contracts: Some factors require a long-term contract or a minimum number of invoices.
Higher costs: Factoring fees can be high, and if your provider wants you to place your entire book with them, you’ll pay fees on customers who have always paid you promptly.
5. Working Capital Advances
Working capital advances are short-term loans that provide businesses with an upfront lump-sum injection of capital. The repayment schedule is quick, lasting from a few months to just over a year.
In addition to monthly repayments, many lenders offer daily, weekly and semi-monthly repayment schedules.
Working capital advances help businesses cover daily expenses when cash is tight or when they’re planning for growth. They can also be a way to pay for less expensive machinery, vehicles, and so on over a shorter period than using standard equipment financing.
Working Capital Advance Advantages
Flexible repayment: In addition to monthly repayments, many lenders offer daily, weekly and semi-monthly repayment schedules.
Quick approvals: Many online lenders offer a turnaround time of 24 hours, meaning the money can be in your account the following day.
No collateral: Working capital advances often don’t require collateral, making them accessible for businesses without significant assets.
Working Capital Advance Disadvantages
High costs: Lower interest rates may be available on longer-term loans, especially those backed by collateral and a personal guarantee.
Faster repayment: The requirement to pay back a large sum of cash quickly may put pressure on general cash flow.
Debt over-reliance: Relying heavily on short-term advances can lead to over-leveraging, making it harder for you to secure funding in the future from lenders.
Choosing the Right Short-Term Financing Option for Your Business
When choosing a short-term financing package for your business, make sure to consider the following:
Need: Take a minute to consider whether you actually need to take out short-term financing. Delaying a purchase and saving may be more cost-effective than taking on debt.
Ability: Find out how much you can afford to repay without causing your cash flow to become strained. Factor in your current financial obligations as well as your future revenue predictions to determine an amount.
Options: Compare the different short-term financing options available to you based on interest rates, fees, and repayment terms. Select the one that provides you with the most leeway and lowest costs.
Apply: Once you’ve made your choice, apply to the lenders or brokers offering the type of short-term financing you’ve decided on. Make one application at a time because the more applications you make, the more your credit score is affected.
Get Flexible Short-Term Financing Through Backd
Short-term financing offers a quick and convenient solution for businesses looking to tide themselves over a quieter period or to boost capital to fund a specific opportunity or purchase.
With so many options available, it’s important to choose one that will advance the amount of capital you require and offer repayment periods that will work for you. By carefully evaluating your business needs and comparing them against the different types of short-term finance that are available, you can choose the most suitable option for your business to achieve your goals while maintaining a healthy cash flow.
Backd provides two types of short-term financing to clients:
A working capital advance of up to $2 million
A business line of credit offering up to $750,000
Apply with Backd now and you could be funded in as little as 24 hours.
