For every early success story, about 20% of small businesses fail within the first year. According to Fundera, about 30% will be gone by their second year and 50% will last five years. For those who weathered the harsh disconnection caused by the pandemic but still remain financially fragile, there are specific loans available to help small businesses stock their product.
Inventory loans, or inventory financing, were created for companies that maintain large amounts of inventory whose value can be used to support their business in a variety of ways. Under the right circumstances and with the right loan terms, inventory financing could be the most sensible loan option for those hoping to boost their business by keeping their shelves fully stocked.
How Inventory Loans Work
Inventory loans are asset-based and given to businesses to purchase more inventory, support net working capital and control cash flow, even if they don’t have sufficient capital available. The inventory your business purchases serves as collateral, and lenders offer financing based on a percentage of that inventory’s value (typically 20% to 80%, per Forbes).
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Because start-ups have different needs, inventory financing might not be the best option for newer businesses. However, these loans are often ideal for well-established, high inventory turnover revenue earners, and are commonly used by car dealerships, retail stores and flexible, seasonal merchants. Many lenders will stipulate that the company applying for a loan be in business at least 6 months.
Inventory loans differ greatly across credit unions and in-person and online bank lenders. When you are looking at inventory financing, you’ll need to closely consider qualification requirements, borrowing limits, repayment terms, collateral demands and applicable interest rates and fees.
Inventory Lines of Credit
There is another type of inventory credit available to small businesses that don’t involve set terms like a loan. Inventory lines of credit are similar to credit cards and are useful if you don’t want to be beholden to a set amount to be paid back.
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A line of credit allows the business owner to access part — or all — of the credit line, repay it, and access it again as needed. You only incur interest charges on the amount you withdraw (as opposed to term loans, where you pay interest on the full amount).
These types of “loans” are based upon a credit evaluation, additional collateral (sometimes), servicing requirements, interest charges and possible annual, appraisal and repayment/late fees. As with inventory loans, defaulting on and inventory line of credit can result in your lender seizing the inventory that you’ve used as collateral.
Pros to Inventory Loans
- Built-in collateral: Inventory loans are typically secured by the purchased inventory, meaning that the lender can take possession of the merchandise in the event of a default. For that reason, this type of loan is excellent for businesses that may not have other assets to offer as collateral and don’t want to put down personal assets as assurance.
- Keeping shelves stocked: When a business gets an inventory loan, it can buy materials and inventory needed to keep their shelves stocked without having to put up their own capital. Inventory loans enable companies to buy large amounts of inventory to meet consumer demand.
- Manage cash flow: As Forbes noted, inventory financing can help businesses better manage their cash flow because they don’t have to purchase all of the merchandise upfront, giving companies more flexibility to buy inventory when it best suits them (when prices are lower, for bulk sales, etc.).
- Easy to apply: Inventory financing typically has a more short and straightforward application process than other business loans. You can often get necessary funds much quicker than with a traditional loan, too.
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Cons to Inventory Loans
- Restricted loan amounts: These might not be the best types of loans if you require a lot of inventory. Lenders typically offer up to a maximum of 80% of the value of the inventory purchased, meaning you’ll still have to pay 20% (or more).
- Inventory and sales fluctuations: Your inventory can depreciate in value over time, creating a greater loss for lenders if they need to sell it (for instance, if the borrower can’t repay). Missed sales expectations due to a drop in demand or a hike in costs can prove problematic for a company and make repayment difficult.
- High interest rates: Favorable rates can be found or bargained for, but generally, inventory loans come with higher interest rates than traditional loans. The main reason being the higher risk — inventory rather than capital — that the lender is taking on in the event of a default on repayment. According to Lantern Credit by SoFi, borrowers can typically expect the following interest ranges from lenders: Banks (3% to 6%), online lenders (8% to 99%) and inventory financing companies (8% to 20%).
