Table of Contents

  • How Inventory Loans Work
  • Inventory Financing: Pros and Cons
  • How to Qualify
  • How to Apply
  • Inventory Loan Alternatives
  • Choosing Your Best Option

Many small business owners turn to inventory financing when their current working capital won’t cover the purchases outright. But what is it, and how can your business benefit from it?

Let’s go over everything you need to know before applying for inventory financing.

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.

 

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 common need. It can be setup like a regular installment loan or a business line of credit, but the key component is how they’re secured.

How Inventory Loans Work

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

Inventory Financing: Pros and Cons

There are pros and cons to inventory financing that could help you choose whether to seek out alternative options.

ProsCons
  • Helps you prepare for busy seasons
  • High loan minimums
  • Can finance large amounts for expanding businesses
  • Higher interest rates
  • Credit lines can rise with businesses
  • Extensive due diligence process
  • Don’t need collateral or assets
  • Ongoing inspections if using a line of credit option

Inventory Financing Pros

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

You can secure inventory financing to buy stock for seasonal needs.

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

Large Funding Amounts

Many inventory financing companies like to work with high loan amounts. This can be a negative for some small businesses (which we’ll get into later), but works well for those that are growing or expanding.

Demand may outweigh the supply you have, and that can be great. If you can’t satisfy it, however, you may lose money and potential customers. Inventory lending makes sure that doesn’t happen.

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.

Many inventory financing lenders offer lines of credit because of their ability to make them continuous income from one borrower. Since you can withdraw more funding after paying off your first round, it’s an appealing long-term solution for retail businesses.

Depending on the relationship with your lender, you may be able to raise your credit limit after showing an ability to repay debts. This can help you as you begin selling more and more products.

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 loans use the products themselves as collateral, you won’t have to worry about losing any personal assets as with other options.

Inventory Financing Cons

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

High Loan Minimums

Inventory financing lenders like to make sure they reduce their risk as much as possible while making enough money to justify taking on what they have to. 

To do so, they impose high minimums to borrowers. Usually no less than 6 figures, they can be as high as $500,000. Since some lenders only will cover up to 50% of your inventory’s value, that could mean you’ll need to buy $1 million in products to meet the minimum.

This may work for large stores such as Walmart and Target, but isn’t an option for smaller retail businesses, car dealers and other businesses who need to purchase inventory.

Higher Interest Rates

For the same reasons the minimums are high, lenders mitigate their risk by increasing interest rates on inventory loans. These higher rates can make it less efficient to borrow from these lenders, causing you to look in another direction.

Small business tip: Your products have a lot to do with the interest rates you can get on these loans. If the lender doesn’t think it’ll be easy to sell if you go into default, rates will 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 and whether it’s a worthy risk for your businesses before making this decision.

Extensive Due Diligence Process

Inventory financing loans have a very extensive application process. After submitting financial documents and information about the products you’re buying, your lender will still need to vet your business further.

They’ll look into your current stock’s value and any inventory-management software you provide. Any losses because of theft or damage are taken into account to assess how you manage inventory currently.

Sales volume and profit margins also will be considered to assess how well you’ll be able to repay your loan. 

Site visits may be scheduled so the lender can get a full picture of your operation, too.

Inventory financing can come with ongoing inspections from your lender.

Ongoing Inspections and Scrutiny

Things change every day for small businesses. A business approved for financing 6 months ago could be in a worse position to pay back a loan today, and lenders know that.

If using a line of credit as inventory financing, your lender will want to keep up with your business to make sure they aren’t taking too big of a risk. This could mean ongoing, unannounced site visits to audit your inventory management and sales.

While this is a minor inconvenience for some businesses, it may turn others away from these types of funding solutions.

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. 

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 to go. 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 may 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 company 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, inventory loans aren’t the answer for every small business. 

Here are some popular alternatives that you can use to buy the inventory you need.

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 long term with a set interest rate.

They will often have lower interest rates than inventory loans that use the products you buy as collateral, 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 your loan back, 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 and can get you funded in as fast as 1 day.

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 financing you’re comfortable with, it’s time to stock up and start making sales.