Business Line of Credit

A business line of credit is a key component of managing your small business financing health. Unlike a business loan, a line of credit acts as ready cash in times of need. In many ways it is similar to a business credit card. A line of credit can be a business lifeline in times of emergency or even seasonal cash flow tightening.

What is a Business Line of Credit and how is it different from other business loan types?

A business line of credit can be seen as a cross between a business loan and a business credit card. Like a business loan, an unsecured line of credit provides business financing that can be used for general business expenses. However, with a line of credit, there is no lump-sum disbursement, a business owner borrows only what is needed and only pays interest on the amounts borrowed.

Like a credit card, the amount of capital available to draw down and the payments are revolving and is usually subject to annual review. Interest begins to accrue only when money is drawn (or borrowed) and interest only applies to those amounts. The lender will set a limit on the amount the business may borrow.

Using A Business Line of Credit

A business line of credit is very flexible in comparison to other loan types. In most cases you will not be asked to specify a particular use for your loan.

That flexibility allows companies to use a business line of credit almost as a safety net or insurance policy against gaps in cash-flow or seasonal lulls in business. Some companies use a line of credit to help increase capacity in times of unexpected spikes in demand.

A business line of credit is ready cash and it is flexible and there is no cost to maintain it. Therefore, it is a solid business practice to open and maintain a business line of credit.

Establishing and Maintaining a Business Line of Credit

Obtaining a business line of credit should be seen as an operational goal like a manufacturing process or other essential business operation function. Unlike a business loan, a line of credit is an asset that is part of your business. Therefore, it is important to understand how to acquire access to a line of credit and how to maintain your business line of credit.

  • 1. Prepare your company to apply for a line of credit

    Set a goal in the future when you will apply for your line of credit, say 6-8 months away. Once you determine your time horizon, follow the rules below to greatly enhance the likelihood of being granted your line of credit and to qualify for higher amounts. Your business credit profile is scored from 0-100 (with 75 being considered excellent). Following these rules will help increase your score:

    • Pay your bills on time - This is a must for any type of credit. Managing bill payment is one of the most challenging things about running a small business. Understand which accounts are reported to the credit agencies and make those bills a priority.
    • Refrain from opening credit accounts - Each time you apply for credit in virtually any form an inquiry is entered into your credit profile. Inquiries lower your credit score.
    • Pay-down existing credit accounts - An important factor in deciding to grant a business line of credit is how much of your available credit you are using. If you are maxed-out on all of your credit accounts, you will have a strong likelihood of being denied. Having credit accounts is a good thing, it shows you are credit-worthy; but you will need to bring your balances down to show that your not over-extended on existing credit accounts.
    • Organize Paperwork - You will need to submit your corporate financial statement. Here is a partial list:
      • Balance Sheet
      • Bank statement(s)
      • Profit $ Loss Statement
      • Business Tax Return
      • Personal Tax Return
  • 2. Requirements for A Business Line of Credit

    To qualify for a business line of credit from an online lender, you'll typically need to show that you have:

    • Credit score 580+ - This refers to your personal FICO score. It is important to maintain your personal score, especially if you have a small, young business.
    • 12 months in business - Lenders will almost always require that you have been in business for at least one year before extending a business line of credit.
    • Minimum Revenue Requirements - $10,000 in average monthly revenues are a guideline. This may vary from lender-to-lender. Just ask your lender before applying.
    • Collateral - Lenders may wish to see your ability to pledge short-term assets (like accounts receivable)
    • Major Derogatory Credit Events - No recent bankruptcies, foreclosures, or tax liens
  • 3. Understanding Your Credit Needs

    Many business owners are so wrapped-up in the needs of their lender, they often neglect to assess their own needs when applying for a loan. Getting money is the whole point, but understanding why you need the money, how much and what it will cost are critical considerations

    • What Type of Loan is Best? - Understand your needs and amount of credit you need. Just keep in mind that a line of credit is a shorter-term type of loan and so the loan amounts are generally lower than conventional term loans.
    • Timing - When do you need the loan? Plan ahead, get a line of credit before you need one. Check the approval guidelines before applying or use an online lender to help understand your credit profile. Your bank is usually the best place to go for a credit line if you have a long, solid history. However, if you have less-than-perfect credit, you may wish to explore your options. Remember, each time a lender does an inquiry against your credit report, it can weaken your credit.
    • Shop Rates - As with any type of small business loan options, know the cost of borrowing. Always compare APR, fees and other features. This is where online lenders can give you an advantage. Once again, if you have a good relationship with your bank, try them first; chances are you will get your best deal with your own bank.

Some advantages of a Business Line of Credit over other loan types.

A business line of credit is one of the most versatile and flexible and
effective financing options for most businesses.

Advantages

Loan Type Business Line of Credit SBA Loan Equipment Financing Merchant Cash Advance Unsecured Business Loan
Average Interest Rate 7%-25% Low as 6.5% 8%-30% Factor: 1.14-1.18 8%-36%
Flexible advantage - - - -
Revolving advantage - - - -
General purpose advantage - - - -
Low Credit score Acceptable advantage - - - -
Ready cash advantage - - - -

Disadvantages

Loan Type Business Line of Credit SBA Loan Equipment Financing Merchant Cash Advance Unsecured Business Loan
Update Documents on each draw? disadvantages - - - -
Collateral disadvantages - - - -
Higher rates for low credit score? disadvantages - - - -

Should You Establish a Business Line of Credit?

In most cases the answer is yes, especially if you are a small business with a limited operating history. Small business owners know that business isn't always smooth sailing. Unexpected and often unwanted surprises are an unfortunate part of doing business.

You may not be able to prevent unforeseen expenses, but you can be prepared for them. Similarly, you may not know when the next big opportunity will arise to expand your business, but when that opportunity presents itself, you want to be able to capitalize on it immediately. That's what a business line of credit is for.

Using a Business Line of Credit Can Greatly Improve Your Credit Profile

Many experts agree that establishing a business line of credit is an excellent way to build your business credit profile. Limiting your borrowing to manageable amounts and making payments on time and paying-off quickly will dramatically enhance your business credit profile.

Having a stronger credit profile will almost always lead to lower cost of borrowing and access to more capital. However, it can't be stressed enough that misusing or irresponsible repayment will definitely lead to higher costs and limited access to future credit. Treat your borrowing responsibly and you will be rewarded.

Is a Business Line of Credit and a Business Credit Card the Same Thing?

No. While there are similarities, they are very different ways to access credit. In general, interest rates for credit cards can be considerably higher than a business line of credit. Also, if you wish to get cash with your credit card, you will likely pay a fee and/or a higher interest rate for a cash advance.

Finally, credit cards require ridgid, monthly repayment schedules. With a business line of credit, you may be able to arrange a custom repayment schedule that fits your business cycle.