Inventory financing options are a hot topic as of late. The most common reason small businesses sought funding in the past year was to meet operating expenses, according to the Small Business Credit Survey. The bracket includes business loans for expenses such as inventory, rent, and wages. However, the same study notes that more than half of all businesses with a funding shortfall didn’t even bother to apply. Weak business financials were cited by 56 percent as the cause, while nearly one-third said lender requirements are too strict.
The good news is that there are many types of inventory lending available, and not all have the same stringent requirements. Below, we’ll explore some of the most common options of inventory financing for startups and small businesses, as well as a couple that are often overlooked, so you can find the best inventory funding solution for your needs.
Top 4 Inventory Financing Options for Small Businesses
Short-term inventory loans, lines of credit, vendor financing, and invoice factoring may all be used to pay for inventory. Each has unique benefits and drawbacks to consider when choosing the right one for your needs.
1. Short-Term Inventory Loan
When most people think of inventory financing, it’s short-term loans that come to mind. In reality, there are two main types of inventory financing: short-term loans and lines of credit. We’ll cover short-term loans first.
What is a Short-Term Inventory Loan and How Does it Work?
By definition, short-term loans have small repayment windows, usually lasting from six months to a year. They’re offered by a variety of banks, credit unions, and online lenders. While you can get a short-term loan with more flexibility to use funds however you want, strong credit is typically required, and most businesses can’t fully fund their inventory needs this way. A short-term loan for inventory is different in that the inventory serves as collateral, so more businesses can qualify.
In addition to having decent credit, businesses must supply the lender with traditional loan documentation, such as profit and loss statements, tax returns, and sales forecasts. Lenders often require an appraisal of the inventory and have reporting requirements that continue through the loan term. However, you may get around some of this by choosing a lender that specializes in your industry and understands the value of your inventory and sales cycles.
Once approved, the funds may be disbursed in one lump sum directly to your vendor or you depending on the loan’s terms. You should expect to put some money down. Around 20 percent is common. Minimums are also common with short-term inventory loans and can reach as high as $500,000 or more.
Fees and interest are added to your balance on top of the principal, which you’ll pay back in installments. Some lenders and loans require daily or weekly payments rather than monthly. Although the ongoing payments can be a hassle, payments on your short-term loan are usually reported to major credit bureaus, so they can help build your credit too.
Pros of Short-Term Inventory Loans
- Can work for businesses with bad credit and startups.
- Your inventory can serve as collateral.
- Funds can be sent directly to your vendor.
- Can help improve your credit.
Cons of Short-Term Inventory Loans
- Fixed fees and interest increase overall costs.
- Rates can be unexpectedly high.
- Down payments are commonly required.
- Inventory may need to be appraised and you may need to report regularly.
- You may need to pay daily or weekly.
- Loan minimums are common and can be hundreds of thousands of dollars.
2. Business Line of Credit
The second primary type of inventory financing is a business line of credit. Just as we saw with the short-term loan, a business line of credit may come from a traditional bank, credit union, or online lender. Business lines of credit can provide general financing options or be inventory focused too.
What is a Business Line of Credit and How Does it Work?
A business line of credit works like a credit card. Your lender approves you for a specific amount, which you can then draw upon as needed. As you pay the balance down, you can draw from the account again until you reach your maximum.
Approval for lines of credit varies depending on whether you’re trying for an unsecured account or one that’s secured by collateral, which in this case is your inventory. Naturally, unsecured accounts require very strong credit and are usually only offered to established businesses that are both profitable and financially stable. There’s a bit more wiggle room when the credit line is secured by your inventory, but your business will still need good credit and will have to supply considerable documentation.
Payment and fees work differently, though. You only withdraw what you need, and you’ll only pay interest on what you take. Sometimes lenders require more frequent payments with inventory-specific lines of credit, but monthly payments are normal. You can build your credit through paying on your line of credit too, but sometimes businesses find themselves only paying interest rather than paying on the principal, which leaves them stuck in a perpetual cycle of debt.
Pros of a Business Line of Credit
- Can be less expensive than short-term financing if paying interest only (no fixed fees).
- Continuous access to cash as you pay down your balance.
- Inventory can serve as collateral.
- You only take what you need.
- Can help improve your credit.
Cons of a Business Line of Credit
- Easy to get caught in a debt trap by only paying interest and not principal.
- You may need to pay daily or weekly.
- Harder to qualify for, especially if not using inventory as collateral.
- Typically has lower limits than short-term loans.
3. Vendor Financing
Sometimes referred to as seller financing or trade credit, vendor financing may be a viable option if your vendors offer payment options. For this type of small business financing, you’ll work directly with the vendor rather than going through a third-party financial institution.
What is Vendor Financing and How Does it Work?
If your supplier invoices you after they’ve delivered your inventory, they’re technically already providing financing. However, sometimes vendors will work out special terms with their most valued and trusted clients. For example, they may provide you with a longer payment term. In these cases, you may be expected to pay for a portion of the inventory on delivery. The repayment schedule, and any interest or fees due, will vary based on your arrangement.
Sometimes vendors are willing to work out other deals too. For example, some will barter and provide inventory in exchange for your finished goods. Others will provide inventory in exchange for a share of your company or profit-sharing.
Pros of Vendor Financing
- Often based on vendor relationships rather than credit.
- Can work for startups and small businesses.
- You can negotiate a deal that works for both of you.
Cons of Vendor Financing
- Financing is limited to the vendor you’ve negotiated a deal with.
- Terms vary greatly and contracts can include unusual rules.
- You must be a skilled negotiator and have a good relationship with the vendor to get a good deal.
4. Invoice Factoring
Invoice factoring is often overlooked as an inventory financing option, but it may be the most ideal choice if you run a B2B business and invoice your clients after goods or services are delivered.
What is Invoice Factoring and How Does it Work?
Invoice factoring, sometimes referred to as accounts receivable financing, unlocks the cash trapped in your unpaid B2B invoices. It works differently than short-term loans and lines of credit because it’s not a loan. Because invoice factoring does not work like a loan, it is one of the best small business funding options available. It’s a funding service offered by a factoring company, it has a quick and easy application process, and qualifying for it is largely based on the creditworthiness of your clients instead of your business or personal credit score. That’s because your clients ultimately settle the balance when they pay their invoices and there’s no debt for you to pay back.
Factoring companies typically run credit checks on your clients and then let you know how much credit can be extended if you choose to factor their invoices. You choose which invoices to factor and when to factor them. You may even qualify for same-day funding. The factoring company then advances you most of the value of the invoice you’ve submitted. You can spend the cash on whatever you need, be it inventory, payroll, or anything else that will help your business. When the client pays, the factoring company sends you any remaining funds minus a nominal factoring fee.
Pros of Invoice Factoring
- You can spend your factoring cash on anything from inventory to growth initiatives.
- You only pay for the invoices you factor.
- Same-day funding is often an option.
- Can work for small businesses, young companies, and even those with bad credit.
- Excellent for growing companies – Obtain more flexibility and leverage than possible with a traditional line of credit.
Cons of Invoice Factoring
- Relies on the creditworthiness of your customers, which may be an issue if you’re serving customers with poor credit or startups.
- Invoices must be to businesses – cannot be to consumers.
Which Inventory Financing Option is Best for Your Business?
Vendor financing is often the best place to start because some vendors, especially if you have a good relationship, will provide longer repayment terms with no fees or interest. But, this can leave them with the upper hand because you then become dependent on the single vendor and whatever terms you set.
Loans and lines of credit are better for strong, established businesses with little debt and good credit because rates tend to be lower, and these options will help build your credit score. However, few businesses meet the stringent requirements, and even fewer receive the level of funding they need.
Invoice factoring is a great alternative if you don’t have strong credit, haven’t been in business long, and don’t want to be tied to a single vendor. It’s also more ideal if you need fast funding or prefer a flexible and on-demand solution.
Get a Complimentary Factoring Quote from Charter Capital
Charter Capital goes above and beyond traditional factoring benefits by eliminating long-term contracts, providing free collections services, offering competitive rates, and more. If you’d like to take the next step or have questions, get a complimentary quote from Charter Capital.