The distinction that matters: what repays it
Forget interest rates for a moment. The cleanest way to separate a working capital facility from a term loan is to ask a single question: where does the repayment come from?
A working capital facility is repaid out of the trading cycle it funded. You buy inventory in March, you sell it in May, the facility is cleared in June. The money that repays it is the money the facility generated. The horizon is short by design — typically three to eighteen months — because the underlying cycle is short.
A term loan is repaid out of general profitability over a period of years. It funds something that keeps producing long after the cash has gone: a fit-out, an acquisition, a second location, a piece of infrastructure. No single sales cycle repays it. The business as a whole does, monthly, out of margin.
Fund a short gap with long money and you pay interest for years on a problem that lasted six weeks. Fund a long asset with short money and you starve the business servicing it.
That is the failure mode in both directions, and it is common. A restaurant group that finances a build-out on a twelve-month working capital facility will spend the whole first year of a five-year asset trying to repay it out of a business that has not yet ramped. A distributor that takes a five-year term loan to cover one seasonal inventory build will still be paying for it four seasons later.
Side by side
| Working capital | Term loan | |
|---|---|---|
| Repaid from | The trading cycle it funded | General profitability over years |
| Typical horizon | 3 – 18 months | 2 – 10 years |
| Payment rhythm | Weekly or daily is common | Monthly, fixed |
| Usual security | General lien, personal guarantee | Lien plus, often, a specific asset |
| Underwriting weight | Bank statements, deposit consistency | Financial statements, debt service coverage |
| Speed to funding | Days | Weeks |
| Cost, broadly | Higher, over a short period | Lower, over a long period |
| Prepayment | Often little or no benefit | Usually saves real interest |
The prepayment trap
The last row deserves its own paragraph, because it catches more owners than any other line in a commercial finance contract.
Many short-term facilities are not priced with interest at all. They are priced with a factor rate: you agree to repay a fixed total, say 1.28 times the amount advanced, regardless of when you repay it. Pay it back in four months instead of twelve and you owe exactly the same amount. The effective cost of the money doubles, and nothing in the contract is broken — it never promised otherwise.
A term loan amortises. Interest accrues on the outstanding balance, so paying early genuinely reduces what you pay. If your plan involves clearing the facility ahead of schedule the moment a receivable lands, an amortising instrument is worth materially more to you than the headline rate suggests. Always ask the funder, in writing, what the payoff figure would be at the three-month and six-month marks.
The daily-remittance question
Short-term commercial money often remits daily or weekly, sometimes as a fixed percentage of card settlement. That mechanic is not automatically bad — it flexes with revenue, which is precisely what a seasonal business wants — but it changes how the business feels day to day.
Before you accept a daily remittance, model it against your worst week of the last two years, not your average week. A payment structure that is comfortable at normal volume can be suffocating in a slow February. If the model does not survive that test, the facility is too large or the term is too short.
The middle option most owners skip
A revolving line of credit sits between the two and is frequently the correct answer for a business with recurring but unpredictable gaps. It is approved once, drawn as needed and repaid as cash allows, with cost accruing only on the drawn balance.
Two things to check before treating a line as free optionality. First, whether it carries a non-utilisation or facility fee — a charge for having it available, whether or not you draw. Second, whether it has a clean-down requirement: a clause obliging you to hold the balance at zero for a stretch each year, which exists specifically to stop a revolving line being used as permanent capital. Neither is a problem if you know about it. Both are a problem discovered in month nine.
A short diagnostic
- Will this be repaid by a specific, identifiable sales cycle? That is a working capital need.
- Will the thing you are buying still be earning in three years? That is a term need, or an equipment facility if it is a machine.
- Is the gap caused by customers paying slowly rather than by not enough sales? That is a receivables problem, and factoring usually solves it more cheaply than debt does.
- Do you need it repeatedly, at unpredictable moments? That is a line of credit.
- Is it covering a loss rather than a timing gap? That is not a financing question, and borrowing will make it worse.
On cost comparison. A factor rate, a discount fee and an annual percentage rate cannot be compared by eye. Before signing anything, convert every offer to two numbers: total dollars repaid, and the date of the final payment. Those two figures are comparable across every instrument on this page. Nothing else reliably is.
When you know which of these you are asking for, the file writes itself and underwriting gets considerably easier. When you do not, you tend to be sold whichever instrument the person in front of you earns most on. If you want a second read on which applies to your situation, describe the gap to the desk.