A Founder's Playbook for Working Capital Loans
“ Never take your eyes off the cash flow because it is the lifeblood of business.” – Richard Branson
Every year, about 305 million startups are created across the world. Only about 10% of these survive. Innovation and perseverance are the North Stars that guide these startups towards success. However, just like a star needs gas to shine bright, startups need a catalyst to drive their innovation – cash.
Cash is the flowing river that nourishes a startup city. From funding innovation to fuelling the growth of ambitious ventures, cash keeps startups going. Where does this cash come from? Sales and revenue are important sources. However, startups often take time, sometimes even a few years, to breakeven. In the interim, working capital loans can help startups meet their cash requirements.
You may have heard how “cash is king” for businesses. Having a strong cash flow ensures that a startup has sufficient liquidity to meet its financial obligations. It allows you to seize time-sensitive opportunities when they arise, beat competition and explore growth through research and development, invest in new markets, pursue strategic partnerships and negotiate better deals. When you are low on cash, a working capital loan can help you meet all of these obligations.
What is a working capital loan and why take one?
A working capital loan is a short-term financial injection that can help you as a business meet daily cash requirements. Unlike other loans that are used to buy equipment or make investments, a working capital loan helps meet everyday operational expenses like paying rent, salaries, buying inventory, or grabbing a sudden growth opportunity. It is essentially used to bridge cash flow gaps.
For startups, working capital is crucial because it can help you buy inventory to scale your business if you are a product-heavy company. If you provide services, then a working capital loan can help you hire the best talent you need to grow. It can also help with meeting seasonal and unexpected expenses.
However, the biggest advantage of a working capital loan is that when you are not worrying about daily expenses and keeping the business afloat, you can focus your energy on exploring new horizons. When your existing products go to market, you can use the excess time and money to innovate. When your employees are paid on time, they are more likely to be satisfied and come up with cool ideas that can catapult your startup to success. When you are slaying in one geographical region, you can implement similar strategies in a new one that can open important doors for your company.
In short, having sufficient cash back up can help you foster an environment of growth, innovation and expansion. When you are not struggling to make every day payments, you can devote time to things that really matter.
What startup metrics does a working capital loan impact?
As we have already established so far, working capital is vital for a startup’s survival. We’ve looked at what is a working capital loan, the ways that it can be used, the types of working capital loans and how it is different from term loans.
It’s now time to look at how working capital and working capital loans from banks and other sources can impact your financials and financial metrics. Here are four key startup financial metrics that are impacted by working capital loans:
1. Cash Burn Rate :
Burn rate is a metric that evaluates how fast a startup uses its cash or burns its cash to operate. Often, early stage startups will have a high burn rate. Having insufficient working capital can result in a high burn rate and put pressure on you as a founder. A working capital loan can help you alleviate this problem and generate enough cash to run the business.
2. Runway :
Runway is the amount of time a startup has before it runs out of cash. One of the leading reasons why a majority of startups fail is due to a lack of liquidity. Sufficient working capital can ensure that your startup’s runway is extended so that it can meet its daily obligations and spend more time on innovation and making an impact.
3. Accounts Payable and Receivable :
Accounts payable is the amount of money that you owe as a business to suppliers and vendors. Accounts receivable refers to the amount of money that customers owe you. When accounts payable and receivables are both high, you will often run into a cash crunch. A high accounts payable can leave your suppliers bitter and unwilling to extend credit to you in the future. This can hamper your business operations. This is where a working capital loan like invoice financing can help you meet your cash requirements.
4. Customer Acquisition Cost :
Customer Acquisition Cost or CAC is the cost of converting a new potential customer into a paying one. Acquiring customers often requires marketing and sales effort. If you have low working capital, you will not be able to allocate money towards getting new customers. This will limit your growth and ability to innovate in different areas. A working capital loan can help you scale your marketing efforts and onboard new customers.
Which type of working capital loan should you avail?
A working capital loan is a broad term used to denote credit taken on to meet daily financial obligations of a business. There are different types of working capital loans that you can consider for different purposes. These are outlined below:
1. Line of Credit :
A line of credit is a pre-approved loan with an upper limit. When you avail a line of credit, you are allowed to borrow money for your working capital requirements until you exhaust the limit. An interest is levied and repayments have to be made over a period of time. You can use a line of credit to meet expenses that you know you will incur over time. A line of credit is useful because you can limit your borrowing to the amount that you will need. For example, if you are an e-commerce company that constantly needs to buy inventory, a line of credit can be useful.
2. Overdraft :
A business overdraft is a working capital loan from banks that you can take when your account balance is nearing zero or has already gone into negative. An overdraft allows you to borrow a certain amount of money with an upper limit, as and when you need it. It is similar to a line of credit, but is borrowed against your bank account. The difference is it is paid back when your account balance increases. If you are in the manufacturing business, you may benefit from using an overdraft facility to meet diverse needs such as purchasing raw materials or fixing a sudden machinery breakdown.
3. Invoice financing :
If you have a pile of invoices from customers that you are waiting to be cleared, you can pledge this at a financial institution to get immediate money. Invoice financing is a type of working capital loan that allows you to wager your customer invoices in exchange for money. When customers pay you, you can pay this back to the financial institution. It can help you meet immediate financial requirements and cut down your wait time. You can also use this to drive research and innovation. Say you are a transportation startup. Routine costs like fuel expenses and vehicle maintenance may arise before you receive client payments. In such situations, you can use invoice financing to meet cash flow gaps.
4. Inventory financing :
Similar to invoice financing, inventory financing allows you to pledge your unsold inventory to get cash immediately. Your inventory works as collateral and allows you to get about 80%-90% of your inventory value as a loan. If you have a large and valuable build-up of inventory that you know will be sold in the next few months, you can avail this form of working capital loan. Retail stores, such as an electronics startup, can use its inventory to get working capital loans.
5. Asset-based loan :
Just like getting a term loan by pledging assets, you can also get a working capital loan from banks by pledging any equipment, land or machinery that you have. The asset works as a collateral for you to get the financing. If you have an asset-heavy business, then this type of working capital loan can see you through immediate cash crunches. As a construction startup, you could avail asset-based loans by pledging your equipment to manage temporary cash flow issues.
6. Non-dilutive working capital loan :
If you have a business that is growing quickly and generating a lot of revenue, you can pledge your revenue streams to get a working capital loan. This is called a non-dilutive loan or revenue-based financing wherein you don’t have to part with any of your equity to get money. Non-dilutive loans are often attractive options to get money for revenue-heavy businesses like SaaS startups. A non-dilutive working capital loan is ideal when you want to innovate.
Can I use a term loan as a working capital loan?
A term loan is typically a long-term loan that is used to buy equipment, land or make big business moves. The tenure for a term loan is longer and interest rates also vary. The difference between a term loan and a working capital loan is the purpose for which the money is used.
While in theory you can avail a term loan for working capital needs, a term loan is seldom used to finance daily business operations. This is because you can use a term loan to finance a big business requirement in the future. If you use a term loan for a short-term need, you may not be able to use it for a big ticket purchase unless you pay it off.
Can I use dilutive funding to meet working capital needs?
Dilutive funding essentially means that you raise equity capital to meet your financial needs. Typically, startups rarely use dilutive funding or divest equity for working capital requirements. Dilutive funding is used to meet larger business needs like growth, expansion or buying equipment.
However, it is possible to use dilutive funding for working capital needs like hiring key talent right away or innovating in the short term. However, if your capital needs are not too big, it is best not to dilute your ownership. The best approach would be to use equity capital for a big ticket need and combine that with working capital requirements.
Giving wings to innovation
Working capital loans serve as the wind beneath the wings of startups, propelling them towards innovation, growth, and success. They inject the necessary financial resources, that empower startups to invest in research and development, scale operations, enhance marketing efforts, and drive market differentiation.
Choosing the right type of working capital loan can provide the flexibility and agility needed to navigate the ever-evolving entrepreneurial landscape. As a startup founder, when you harness the power of working capital loans, you can unlock your startup’s true potential, nurturing innovation and creating a lasting impact in your respective industry.
If you are considering a non-dilutive funding option to meet your working capital requirements, Recur Club provides easy and hassle-free funding. Check it out here.