Working Capital Financing

Description:

  • A common type of working capital financing is a line of credit in which the maximum amount available for borrowing is tied to the amount of working capital (accounts receivable plus inventory less amount owed to suppliers and employees) on the company's balance sheet.

Pros:

  • The amount available for borrowing will grow as the borrower grows.
  • Can help smooth out fluctuations in cash flow due to seasonality or a large, slow-pay customer.
  • Low interest rate and non-dilutive or minimally-dilutive.

Cons:

  • Not suitable for pre-revenue companies or SaaS companies that lack accounts receivable and inventory.
  • A revolver is a short-term loan. As inventory is sold and accounts receivable are collected, the borrowings based on those assets must be repaid. As new inventory and accounts receivable are added to the balance sheet, new borrowings are obtained. If revenue declines, the borrowing base will also decline. 
  • Revolver is typically renewed annually. If not renewed, the revolver must be repaid upon expiration.
  • Lenders prefer that the borrower is profitable (or close to it) or VC-backed. Otherwise, the borrower may have to pursue an alternative type of working capital financing such as "factoring" in which customer payments are made directly to the lender.
  • Lender will require financial covenants (e.g. minimum revenue, maximum loss, equity raise by a specified date).

Typical borrower:

  • Company with accounts receivable and/or inventory and VC-backing.

Typical lender: