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Inventory Financing for Small Business

By Elise Moores Managing Editor at Fast Capital 360 Reviewed By Mike Lucas

Many small business owners turn to inventory financing when their current working capital won’t cover the purchases outright. 

  • What is inventory financing?
    Inventory financing is any type of loan, line of credit or other funding solution that small businesses use to purchase products and stock.


Let’s go over everything you need to know before applying for inventory financing, including the lending types, how your business can benefit from it and what inventory financing lenders want from applicants.

Is Inventory Financing Right for Your Business?

If you’re wondering how to buy inventory for a retail store, restaurant or other product-based small business without the necessary cash flow, this could be an option for you. Some specialized lenders focus on the automotive space, offering inventory financing for dealers, auto-repair shops and auto-parts stores.

Although you can use many types of funding to buy stock, there’s a common inventory loan structure built specifically for this need. It can be set up like a regular installment loan or a business line of credit, but the key component is how they’re secured.


How an Inventory Loan Works

The products a business buys with inventory loan funding act as collateral to secure the financing. This is similar to equipment financing. Note that both types of funding open up opportunities for small businesses that don’t have the necessary collateral to secure other types of loans.

During your repayment period, the inventory is yours to sell. The revenue you generate is used to pay back your loan. Consequently, lenders assume the risk when products don’t sell. If a borrower misses payments or defaults on the loan, the lender will repossess and liquidate the products to recoup money.

Because of the risk, inventory financing companies rarely (if ever) will finance 100% of the value of the products. You’re more likely to receive 50%-80% of the value, leaving you to pay the rest.

That percentage isn’t of the retail value, however. It’s usually calculated based on the liquidation value of the product, which can be much less. This is a big consideration for many small businesses seeking inventory financing.

Inventory Financing Rates

Inventory financing rates will vary based on whether you get a loan tailored for buying stock or use another type of funding solution to accomplish your goal.

There’s an increased risk with disbursing inventory lending, meaning interest rates will be higher. Lenders have to try and get value for your products if they need to sell them, but that can be difficult. Increasing interest rates are a way to mitigate that risk. Therefore, it isn’t uncommon for inventory financing rates to be in the teens or exceed 20%.

Other inventory business loans and lines of credit can have lower rates, but they can require collateral or personal assets to secure the financing. You’ll have to determine what your priorities are when you choose which funding option you think is right for your small business.


Types of Inventory Financing

If you think inventory financing is the best option for your business, there are 3 types to consider: an inventory loan, an inventory line of credit or vendor inventory financing.

Inventory Loan

With an inventory loan, you’ll receive one lump sum of funding from a lender to finance your inventory purchases. Given the typical high turnover rate for retail inventory, it’s more practical to get a short-term inventory loan you’ll pay off in less than 2 years rather than longer-term inventory financing loans.

You can obtain inventory business loans through banks or alternative lenders; rates and terms will depend on the lender and, in part, your creditworthiness and business’s financial picture.

Inventory Line of Credit

If you haven’t been in business for long, or if your credit history is less than stellar, you might decide a line of credit from an alternative lender is how to get money for your inventory. With this type of inventory financing, a lender will approve a credit line — ranging from tens of thousands of dollars up to hundreds of thousands of dollars — that you can draw from to buy inventory. 

Like a credit card, you’ll repay (and pay interest on) only the amount of money you withdraw.

Vendor Inventory Financing

Rather than obtaining financing through a lender and then purchasing your inventory, this type of inventory lending is directly handled between you — the business owner — and your vendor. There are 2 types of vendor inventory financing:

  • Debt financing: In debt financing, the vendor loans money that you’ll use to purchase inventory. You can repay the loan, with interest, with your sales revenue.
  • Equity financing: With this form of vendor inventory financing, the vendor supplies their goods in exchange for stock in your company. While you won’t have to repay them for the cost of the inventory, your vendor will become an equity shareholder in your company — meaning they’ll have a say in future decisions the company makes.

Vendor inventory financing is a good option for businesses that either don’t qualify for other funding options or don’t want to incur debt from a lender. It can also be a mutually beneficial arrangement by helping to build or cement a relationship between you and a vendor. However, remember that interest rates from vendor debt financing can be higher than what you’d get from a lender.


Inventory Financing: Pros and Cons

There are pros and cons to inventory financing.

ProsCons
Helps you prepare for busy seasonsHigh loan minimums
Can finance large amounts for expanding businessesHigher interest rates
Credit lines can rise with businessesShort terms
Don’t need collateral or assetsRestrictions on use

Inventory Financing Pros

The advantages of taking out inventory financing make it an attractive option for many small businesses.

A business owner checks inventory at his hardware store.

Funding for Busy Seasons

If you’re looking to buy inventory for a retail store that makes their money in a specific season, you may not have the cash flow up front to get what you need.

For example, a garden center will make most of its money in the spring and summer months, when people are looking to beautify their outdoor spaces. This means they need to have a lot of inventory on hand to meet the demand, but they may not have made enough money during the slow months to purchase enough stock.

That’s where inventory business loans come in: You can supplement your own working capital to buy the inventory you need to satisfy customer demand.

Fluid Lines of Credit

A business line of credit is a versatile funding solution for businesses that have ongoing working capital needs. When used as a business inventory loan, the financing can be a renewable source of income for a growing retail operation.

Since you can withdraw more funding after paying off what you borrow from inventory financing lenders, it’s an appealing reupping solution for retail businesses.

No Need to Risk Personal Assets as Collateral

While it’s possible to get unsecured business loans, most lenders need some type of collateral to approve a loan. This often means a business owner’s personal money, vehicles or even one’s house can be at risk.

Since inventory business loans use the products themselves as collateral, you won’t have to worry about losing any personal assets as with other options (unless you’ve signed a personal guarantee).

Inventory Financing Cons

Although the advantages are attractive, there are a few reasons why inventory financing doesn’t make sense for everyone.

Higher Interest Rates

Lenders mitigate their risk by increasing interest rates on an inventory loan. These higher rates can make it this type of financing more costly.

Small business tip:

Your products have a lot to do with the interest rates you get on these loans. If the inventory will not hold its value or is difficult to liquidate, rates can be steep.

It’s possible to get a lower rate to purchase the same inventory products if you use another source of collateral. Think about what you can offer up before making this decision.

Short Terms

Since lenders always want to minimize their risk, you’re likely to receive a short-term length on your inventory loan. They need to liquidate the products in case of default, so offering term lengths between 6-12 months means they’re less likely to be stuck with outdated items they can’t sell.

Although it’s possible to receive a longer term, most inventory financing loans carry a 6-12 month repayment term. Shorter terms may be a boon for those who don’t want to lock up their capital long term, but for others, it raises payment amounts.

If you want to drive down monthly costs with a long-term repayment schedule, you may need to find another funding option.

Two businesswomen consult records on a laptop as they check inventory in a warehouse.

Restrictions on Use

The need for lenders to minimize risk also leads to restrictions on what you can use an inventory loan for. Products that will quickly become outdated or difficult to liquidate are unlikely to qualify.

Some examples could be computer equipment that isn’t up-to-date with the latest technology, perishable products and some seasonal items unlikely to have future value, like New Year’s Eve decorations with the current year printed on them.

In short, inventory financing lenders are unlikely to offer you funding if they don’t think the product will sell based on your industry, sales or demand. This could lead you to seek out other forms of financing, such as a merchant cash advance.

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How to Qualify for Inventory Financing

The qualifications for inventory financing can be more extensive than other loans in some ways, but less strict in others.

Since the loan is secured by a product, your credit score won’t be as much of a factor to lenders. Your ability to repay the loan is directly correlated to how well you can sell the product, so that’s the main focus. That doesn’t mean it will be easy to secure a loan with poor credit, but you won’t need a score of more than 700 just to be considered.

One thing you will need that aligns with other business loans is a strong track record. Inventory financing companies like to see a pattern of being able to sell inventory quickly and with a solid profit margin. Usually, you’ll need at least a year in business to prove that. It’s unlikely you’ll be approved with anything less.

If you need a startup inventory loan, you’ll likely have to find another option.

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How to Apply for Inventory Financing

The process of applying for inventory financing is more exhaustive than most other options because of the extensive vetting process. It can take weeks or months to receive an approval and even longer to receive the funding you need.

Compile Your Financial Documents

One way to speed up the process is to have all of your financial documents ready. You’ll want to have as much of the following information on hand to give your lender a full view of your small business finances:

  • Balance sheets
  • Profit and loss statements
  • Personal and business tax returns
  • Bank statements
  • Sales forecasts
  • Inventory lists and management records

Complete and Submit an Application

The next thing you need to do is to fill out an application. Depending on who your lender is, this might be an online application.

You’ll need to include normal business and personal information and provide copies of the financial documents you put together.

Enter the Due Diligence Process

If your lender thinks your business could be a match for them, they can pre-approve you for inventory financing. This means they want to move on to vetting your business on a more granular level.

At this point, the lender gives you an approximate amount that you can be approved for and a tentative interest rate to see if you’re still interested in moving forward with the due diligence process, which is costly and takes time to complete.

Small business tip:

Some lenders may require a small fee to continue onto the due diligence process of the application. It’s important to assess their tentative offer before spending more time and money pursuing this option.

Await Final Approval and Make Your Decision

Your inventory financing lenders will perform an audit of your business’s sales and inventory operations. During this period, you’ll get a good sense of whether you’ll be approved.

If you end up being approved for an inventory loan, you can then assess the terms of the agreement. Make sure to consider the annual percentage rate of the loan before signing. If you don’t like the terms, you can always try to find another option that can better suit your needs.


Inventory Loan Alternatives

Due to the high minimums and interest rates, as well as the lengthy process, loans secured by inventory aren’t the answer for every small business.

So, how else can you get money for inventory? Here are some popular alternatives that you can use:

Term Loans

A term loan is what most people think of when they think of a business loan. You get a lump sum of money that you pay off over a set period with interest.

They will often have lower interest rates than loans secured by inventory, making them a great alternative. They do, however, also have strict qualification minimums that can push many toward other small business loans.

Short-Term Loans

As the name suggests, short-term loans are similar to term loans but with shorter repayment lengths. Instead of having years to pay back your loan, these loans can have terms as short as 3 months.

The shorter repayment terms mean businesses with less than excellent credit can find better chances of approval. Many online lenders offer short-term loans, making it a great inventory financing option for small businesses who need money quickly.

SBA CAPLines

Although there are other options from the Small Business Administration’s 7(a) loan program that can be used to buy inventory, CAPLines stand out.

If you’re looking to buy inventory for a retail store or other small business that has seasonal sales increases, the SBA Seasonal CapLine is for you.

This SBA inventory financing option works as a business line of credit, with a maximum of $5 million. They can be used to purchase inventory to meet the need of an upcoming busy season. Maturity lengths can go up to 10 years, making them a great choice if you prefer a long-term commitment.

As with any SBA loan, they can be difficult to be approved for. If you are, it takes weeks to months to get your money.

Business Line of Credit

If you need inventory financing immediately or don’t have the creditworthiness to be approved by the SBA, you can still receive a business line of credit from alternative lenders.

If you choose to go this route, you can withdraw funding from the line of credit in the future to cover operating costs other than inventory. That versatility could be beneficial for growing small businesses.

The speed and accessibility to funding that online lenders offer makes business lines of credit attractive.

If you go through an online lending marketplace such as Fast Capital 360, you can have one application sent to multiple lenders. This cuts out the time you have to spend filling out applications. 

Qualification requirements also are much lower than SBA, bank and inventory loan lenders, opening up doors for businesses with lower credit scores.


Choosing Your Best Option

Inventory financing is a necessity for many small businesses. It’s important to make the right choice.

Using the products you need to buy as collateral can help some, but inventory loans aren’t an option for everyone.

Some of the alternatives can offer opportunities that make sense for many small businesses, but they come with their own set of pros and cons.

Make sure to look into all of your options to find the one that matches your goals. Once you’ve found the inventory lending option you’re comfortable with, it’s time to stock up and start making sales.

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