How Could Your Business Benefit From a Business Line of Credit?
If you own a small business, you probably already know that sometimes you need a little extra cash. Even the most successful small businesses experience slow sales, late invoice payments, urgent unplanned expenses, and other short-term situations where cash flow is uncertain. In situations like these, access to some extra working capital can mean the difference between closing your business or surviving the tough times and coming out on top.
When considering financing, small business owners have an overwhelming array of different options available to them. A business line of credit is one of the most popular choices for small business owners. Read on to learn more about this type of financing, examples of why your business should have a line of credit, how to apply for one, and some alternatives to consider.
What is a business line of credit?
A small business line of credit is a financial tool that has much in common with a business credit card. Unlike a term loan, a small business line of credit does not provide a lump sum of cash that requires a monthly repayment schedule. Instead, it offers the borrower access to capital up to a certain amount. Similar to using a business credit card, you can access the capital as you need it to pay for business expenses. The balance on a line of credit is “revolving,” meaning that you can carry the balance from month to month and interest is calculated based on the amount you draw. As you repay that amount (called the “principal”), your available credit goes back up to your limit, allowing you to replenish your credit and use it again.
When small business owners start looking for funding, many start their search by researching term loans and business lines of credit. One key difference between those two options is that a business line of credit is flexible in ways a term business loan is not. With a business line of credit, you could borrow an amount up to your credit limit, and you would pay interest on the amount that you borrowed. Fees vary depending on the lender and the precise line of credit you choose; look out for inactivity fees, and other additional fees. The main constraint of a line of credit is that you cannot go above and beyond your credit limit.
Why Might You Need a Business Line of Credit
All businesses need cash to run their operations, but sometimes there just isn’t enough cash right when you need it. You might be waiting for your favorite big client to pay their invoice, or you might need to purchase an expensive new piece of equipment. Situations like these may seriously affect your cash flow and threaten the stability of your business. If you’ve got a line of credit in place, however, you can handle these challenges with confidence.
Business commonly use their business line of credit as a tool to help them grow their business and accomplish more, faster. For example, a credit line can come in handy for things like:
- Hiring new employees to meet growing demand for your services
- Purchasing a new piece of equipment
- Opening a new office or expanding to several new locations
- Purchasing extra inventory to get ready for your busy season
Business owners also commonly use their business line of credit as a safety net when they face things like making payroll during slow seasons, work shortages, or surviving a temporary dip in sales. In short, a business line of credit is useful for smoothing most liquidity or cash flow volatility problems that business owners commonly face.
With a business line of credit, you won’t have to worry because you will have access to funds when you need them most. Your credit line is simple to use, especially if you’re used to using a business credit card: Once you receive your funds, you can pay off the business line of credit to replenish it, and use it again when the next need arises.
Secured Business Line of Credit vs Unsecured Business Line of Credit
Business lines of credit fall into two main categories: Secured and unsecured. Here are the main differences between the two types:
- Secured business line of credit: In a secured business line of credit, the lender asks the borrower to pledge their assets against the loan as collateral. Since this is a temporary liability, the lender may accept inventory or accounts receivable as collateral. They probably won’t ask for large assets like equipment or real estate. If the business fails to pay off the business line of credit loan, the lender will take the collateral.
- Unsecured business line of credit: Most business owners looking to get a line of credit prefer this option because the lender does not require any assets as collateral. This is necessarily riskier for the lender, which means that there is a higher bar to meet in order to get approved. To get approved, you will need to prove that you have good personal credit, good business credit, and a track record of generating revenue. Unsecured business lines of credit are often given for lower limits and at higher interest rates.
Things to Consider When Choosing a Business Line of Credit
It's generally easier to apply and get approved for a business line of credit before you actually need it. When you and your business are in a sound financial position, rather than a desperate one, you’re a much more attractive borrower from the point of view of a bank! You might think you don’t need extra cash right now, but if you’ve been approved for that line of credit, there’s no time limit on when you can use it, and you’ll then have a backup if you are faced with an sudden cash flow emergency.
If you do apply for a line of credit when you’re in a strong financial position, the lender will probably be more enthusiastic about negotiating interest rates and other terms and conditions, meaning you’ll get the most favorable deal possible.
If used wisely, a business line of credit is extremely beneficial and convenient monetary tool that can help your business become and remain successful.
Any lender will want to scrutinize your business credit history before it approves you for a business line of credit. We’ll outline the pros and cons of getting a business line of credit so that you can decide if it’s the right choice for your business.
Pros Getting a Business Line of Credit
- Flexible Process - One of the fundamental benefits of a business line of credit is its flexibility. Once approved for a business line of credit, you can draw funds when you need them, and use them for whatever legitimate business purpose you want.
- Interest only on the portion of credit you use (sort of) - An important benefit is that with a business line of credit, you aren’t charged interest on the unused portion of the funds, only the part you actually use--plus fees, depending on the situation. For example, if you have $60,000 and you use only $20,000, you will only have to pay interest on the $20,000 used. This is in contrast to a term loan, where you are charged interest on the full lump sum. When it comes to fees, make sure you understand them up front. Some lenders will charge fees to keep your account open, fees for “inactivity” and other fees, so it’s always a good idea to thoroughly understand and inquire about any potential fees before you commit.
- Lender-borrower relationship – Cultivating a good relationship with a lender can be extremely beneficial later on. If you develop a good relationship with your lender through responsible use of credit, this can lead to help from your lender if you need a credit increase, or further finances for projects in the future.
- Better Business Credit Rating - If your lender reports back to the credit bureaus, using your line of credit carefully and repaying on time can be a good way to build credit. This can benefit you by raising the credit rating of your business. This can help you in the future if you ever need more credit or a term loan. As your lender if they do report back to credit bureaus; not all of them do.
- Lower Interest and lower fees than other popular options...usually!- For some business expenses and situations, it’s often better to use a business line of credit from a large bank than a business credit card, because a business line of credit typically does not have as high an interest rate as a credit card. A business line of credit operates like a credit card as explained above, with a revolving balance, but they tend to offer lower interest rates, and there are no fixed payments. Though it’s important to check the lender’s terms and conditions before applying for a business line of credit, most of them are flexible and allow you to pay off the complete balance when it’s convenient for you; you generally won’t have to lose sleep over a prepayment fee.
This last “pro” comes with a few big caveats, though: There are lines of credit out there that are just as expensive as credit cards, if not more so. And even if a line of credit doesn’t come with prepayment fees, they might drastically front-load the fees, so you don’t save much by prepaying. If you are hunting for lower fees, it’s always wise to compare carefully and ask a lot of questions before deciding.
Cons of Getting a Business Line of Credit
- Difficult Application Process - Applying for a business line of credit from a major bank is not a quick and easy process. It will most likely entail providing the lender comprehensive financial statements and revenue reports, including cash flow statements, tax returns, as well as your personal credit history and personal information.
- Fees and Charges – Even though a credit card often has higher interest rates than most business lines of credit, a business line of credit loan might lead to hefty withdrawal and maintenance fees. It’s important that you try to negotiate a low rate of interest to account for such fees, or at least be aware of them so you can avoid as many fees as possible.
- Possible Debt Spiral Situation - One big problem to keep in mind is the slippery slope of debt. If at some point, you are unable to pay back the money owed because of a decline in sales or any other reason, you could find yourself in a hole of debt with your lender. It’s easy to get into a debt spiral and very hard to get out: If you can’t make your full payment for some reason, then it spills over into your next payment period, but the interest compounds on the new principal amount. That means, one missed payment can lead to larger and larger payments in the future. This can go on indefinitely and is a situation that you will absolutely want to avoid.
What are the requirements to get a business line of credit?
In order to get approved for a business line of credit from a bank, you’ll need to complete a thorough application process. When you apply, the prospective lender will review your financial statements and assets, and more. Here are some common requirements for getting a new business line of credit:
- Collateral:As we discussed above, a secured business line of credit is safeguarded by collateral which you provide. This may include (but is not limited to): real estate equity, physical inventory, equipment, or accounts receivable. Your business guarantees the loan with that collateral, reducing the risk for the lender. Often the lender will tell a small business to pledge all of its assets to secure a business line of credit.
- Business operating time:A general guideline is that only businesses that has been in operation for at least two years will qualify for a business line of credit from a bank. If the lender feels a startup has good collateral and sound personal credit, it can make a rare exception.
- Financial statements and reports:According to the US Small Business Administration and recently reported in USA Today, only 20% of new businesses survive past their first year of operation. That’s one reason why, most banks require extensive financial statements along with income tax returns spanning at least two years in order to consider your business for a line of credit.
- Profit and revenue:Your business should generate revenue in order to be eligible for a business line of credit. When you apply, you will be asked to provide proof of revenue and business health. In cases where there is not enough income or profit to satisfy the lender, the business may have an option to provide collateral in case of default.
- Guarantee: If your business is a subsidiary of a big organization, the lender needs the parent organization to give a guarantee for your subsidiary before it gives a business line of credit to the subsidiary. If you’re an independent small business owner, you would need to make a personal guarantee.
- Economic ratios:By cross-checking certain important economic ratios of your business, the lender can estimate your business performance. These ratios may include:
- Debt to equity
- Current ratio
- Debt service coverage ratio
- Fixed charge coverage ratio
Where to Apply for a Business Line of Credit?
If your business is looking for an unsecured business line of credit, there are many lenders in the market. For example, credit unions, online banks, online lenders, commercial banks and community banks. Credit limits can be as low as $5,000 and as high as $500,000. On the low end, you would most likely be dealing with smaller banks or online lenders, since banks almost never go as low as $5,000.
If the business is less than two years old, certain banks will give a business line of credit in partnership with the Small Business Administration, or SBA. The SBA CAPLine program provides businesses that meet its requirements with four different business lines of credit for their temporary working capital requirements.
An Alternative: Why Not Try Fundbox?
Fundbox might be an attractive option for your business, especially if you are just getting started. Fundbox, a fast-growing online lender, if approved, can provide your business a business line of credit that suits your needs and helps to quickly fill up the hole in your cash flow. There is no paperwork and no personal credit investigation to get started. You can be eligible for up to a credit of $100,000. The only real requirement is that your business must have been in business for at least three months.
Why might Fundbox be the best choice?
Fundbox just recently made it to the Forbes Next One Billion-Dollar Startups to keep an eye on in 2017. Read on to find out why and determine whether Fundbox is the right choice for you:
- Transparent fees:Pricing and fees are transparent. There are no application fees and no origination fees, just a weekly fee when you draw. You need to pay approximately 0.7% per week on the credit withdrawn with a 12-week or 24-week repayment plan. This would translate into $7 per week per $1,000 withdrawn. With the 12-week repayment plan, the fee is lower, and the weekly payment amount is higher, but with the 24-week repayment plan, the fee is higher, and the weekly payment amount is lower.
- Easy eligibility:You can be eligible to get a business line of credit with Fundbox within just six months of starting your business. There are no minimum credit score requirements, or monthly income requirements, and just six months of business operations. You can get your business line of credit approval and funds access by the next business day after approval.
- Collateral and personal guarantee not required:With Fundbox, you don’t need to pledge a collateral just in case you are unable to pay back your business line of credit loan. You also don’t need a personal guarantee for credit limits that are lower, so if there is a fall in sales or you are not able to repay your loan, you will not be responsible personally.
- Flexibility:With Fundbox, you can pay back your business line of credit early. This will save you feels and, subsequently, help reduce your yearly percentage rate.
How to Use Fundbox?
To use Fundbox, which operates with most national, regional, and local banks and credit unions–over 12,000 financial institutions in all–you can just connect your business banks account, or you can connect your compatible invoicing or accounting software such as:
- QuickBooks (both Desktop and Online)
- Zoho (both Books and Invoice)
- Sage One
If you don’t use any accounting software from this list for your business, you can just connect a bank account and get started.