January 6, 2020 | Last Updated on: June 16, 2023
When a business hits its stride, growth can often be stifled due to a lack of credit. There are lots of options out there for small business loans and financing, but sifting through the noise can be a tall ask for someone without a strong financial background. Taking the time to understand the process can help in securing a business line of credit for your company. A business line of credit can be an attractive credit option for small business owners looking to up their business financing game, but even the most experienced entrepreneurs have questions about them. Who offers lines of credit? How do they work? What’s a secured vs. unsecured line of credit? How do I qualify? Whether you have a new or established business, we’ve put together a quick primer on business lines of credit and how you can best set yourself up for approval.
A business line of credit is somewhere between a short-term business loan and a business credit card. Unlike a term loan, you don’t make monthly payments against a lump sum given upfront, and unlike a credit card, you aren’t charged steep interest rates. Business lines of credit are short-term financing options that small business owners use in order to improve cash flow or get access to quickly available working capital. They are a flexible financing option for growing businesses. The credit line is open and available to you whenever you need it with a certain credit limit, and you only pay interest on the amount that you’ve drawn. Once you pay back any portion of the line of credit that you’ve used, it’s available for you to borrow again.
Small business owners often need short-term cash infusions and easy access to working capital to grow and expand, cover unexpected purchases or capital acquisitions, or to compensate for cash flow during slower periods of the year. Business lines of credit offer greater flexibility than other short-term financing options and thus are a great option to add to your financing arsenal.
Lines of credit come in two main forms: secured and unsecured. Secured lines of credit are guaranteed by business assets like accounts receivable or real estate, and because of this often come with lower interest rates. An unsecured business line of credit has no such guarantees, sort of like a business credit card, and thus comes with higher interest rates.
Whether the financial institution in question is a traditional bank or an innovative online lender, getting a business line of credit relies on the same key principles. We’ve outlined the five most important requirements to meet in order to maximize your chances for approval.
Just like any other type of financing, lenders want to see that you and your business have a good history of handling credit. Lenders will pull personal credit scores, business credit reports, and other indicators of creditworthiness in this evaluation. If you or your business has a history of poor credit or delinquency, it can hurt your chances of qualification, restrict the loan amount, and steepen the rates charged. The common minimum credit scores required for a line of credit are 680 and 600 for traditional banks and online lenders, respectively.
Banks want to see that you’re business is operating successfully and will be able to handle the burden of additional debt. Lenders will look at previous loans and their repayment terms, profit/loss statements, your company’s balance sheet, balances in bank accounts, and anything else that they see as necessary to determine your company’s ability to take on extra debt.
In their evaluation, most lenders use common financial ratios to get a sense of whether or not lending to a business is worth it. Below are the three most important ratios to consider:
The theme surrounding all of these ratios is an evaluation of liabilities on your balance sheet and how you’re able to deal with those liabilities. If you can show that your business is able to pay back debts in a timely manner and/or doesn’t currently hold too much debt, lenders will feel more comfortable extending credit to you.
To get a business line of credit, banks need to see that you have demonstrated business needs and a history of success. A history of strong revenues shows that you’re able to competently run a business in the long-term and thus have less risk. Though it’s less likely, banks will offer lines of credit to startups if the founder has a good personal credit history and/or makes a personal guarantee on the loan. A common threshold for minimum qualification is $25,000 in annual revenue and being in business for 6 months. Relatively large credit lines can have more robust requirements, and each lender is different. Again, online lenders are usually a bit more lenient when it comes to this. Just be aware that their leniency comes with higher rates that could make financing less affordable.
If a potential debtor is perceived as relatively risky or the requested line of credit is particularly large, lenders will often ask for some sort of collateral or guarantee so that they can hedge their bet, so-to-speak. The collateral could come in a number of forms. Accounts receivable, business real estate, high-value equipment, inventory, and a number of other assets are commonly used. Sometimes the collateral will constitute a mix of these assets. The small business administration (SBA) can help make a business line of credit work by providing the guarantee necessary to make a lender more comfortable. Look into the 7(a) loan program offered by the SBA to see if they can help you secure a good line of credit. The SBA will connect you with lenders offering SBA-backed lines of credit and will act as a “guarantor of last resort” after banks exhaust all possible personal or corporate guarantees.
