A Look at Capital Loans

Capital loans are designed to provide businesses with the cash needed to fund development. Capital loans may be provided when a business is first opening its doors, but most capital loans are extended for working capital purposes. A working capital loan is given to a business that is already profitable but may not have the liquidity to fund expansion or fill current work orders. By taking on a degree of debt financing, the business can continue to operate without liquidating assets.

Business Debt Financing

Most businesses within the United States, and worldwide, operate on some type of debt financing. This is necessary because businesses are constantly looking to expand. Employees request raises, business owners would like to increase their earnings and there is a constant threat a business will lose clients if it does not expand. By only using its current profits to fund expansion, a business is limiting itself. In order to compete, it must go after new profit. Ultimately, a manageable amount of debt can be a sign of financial vitality for a company rather than a sign of detriment.

Obtaining a Capital Loan

A capital loan is given based on the borrower's likelihood to repay the debt. Likelihood to repay can be measured with business credit, business assets and a quality business plan. A lender will first look into the financial history of the company to determine whether it has a good record of repaying debts. The lender will also consider the company's overall financial health, checking to see how many other debts it still has to repay and how much it earns on a monthly basis. If the business has assets, those assets will be considered as a positive factor in obtaining a loan. Finally, a lender will review the company's business plan to determine if it is likely to continue earning a profit in the future.

Capital Loan Example

John's Print Shop currently prints about 1,000 brochures for small businesses each month. John recently spoke with 10 new businesses who would like to order their printing through his shop. Unfortunately, John does not have enough printers to handle this order. He approaches a local lender to request a capital loan for two new printers. He shows the lender his record of payment, and he also includes information on the new print orders in his business plan. The lender agrees to finance the purchase of two new printers because it has a strong feeling John's profit will go up enough to pay down the debt in the future.

Capital Loan Risks

The main risk of a capital loan is it typically requires collateral. In the above example, the printers themselves would likely be collateral, but John may even have to put more collateral down with the lender. If he is unable to repay the debt for any reason, the lender can seize the entirety of the collateral. For example, imagine only 5 of the 10 businesses John hoped to work with ended up hiring him. His profits are not large enough to repay the lender, and the lender reclaims the printers. John is back where he started, and he must break deals with the 5 new companies because he no longer has printers to sustain the business.