Business Line of Credit
If you own a business, you probably already know that sometimes you need access to working capital to help you grow. Even the most successful small businesses experience late invoice payments, urgent unplanned expenses, and other short-term situations where cash flow is less than certain. In cases like these, access to some extra funds can mean the difference between closing your business or surviving the tough times and coming out on top.
When it comes to business financing, you’ve got an enormous array of different options to consider. A business line of credit is a popular choice among small business owners.
Read on to learn more about this type of financing, examples of why your business should have a line of credit, and how to apply.
What is a business line of credit?
A line of credit is a predetermined amount of funds that you can borrow from when you need to and pay back later. Unlike a traditional term loan, you can use the funds as and when you need them for business purchases like inventory, supplies, or operating expenses. Unlike a term loan which has a fixed monthly repayment, you can typically pay back your credit line anytime, without any early repayment fees. Calculate the estimated pricing with our line of credit cost calculator.
A critical difference between lines of credit and term loans is that lines of credit are “revolving.” That means you can use the funds, up to your approved amount, then repay what you’ve used to make the funds available again. Term loans, on the other hand, are lump sum loans that you use once and repay once, with interest.
How you could benefit from a business line of credit
All businesses need access to funds to run their operations, but sometimes there isn’t quite enough working capital available 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 even threaten the stability of your business.
If you’ve got a line of credit in place, however, you can handle these challenges with confidence, knowing you have access to the capital you’ll need.
Businesses commonly use their business line of credit as a tool to optimize cash flow and take advantage of new opportunities.
For example, a credit line can come in handy for things like:
Hiring new employees to meet a growing demand for your services
Opening a new office or expanding to a new location
Purchasing inventory to get ready for a busy holiday season
Running marketing campaigns
Business owners also commonly use their business line of credit to smooth their cash flow 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 handling liquidity or cash flow volatility challenges that many owners commonly face.
A business line of credit can help you run your business with less stress since you will have access to funds when you need them most. A credit line is revolving and simple to use—especially if you're used to business credit cards. Only pay for what you use. Once you receive your funds, you can repay to replenish your available credit limit, then draw again when you need it.
The difference between secured vs. unsecured credit lines
Business lines of credit fall into two main categories: secured lines and unsecured lines.
Here are some crucial differences between the two types:
Secured business line of credit: With 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 will not ask for significant assets like equipment or real estate. If the business fails to pay off the business line of credit loan, the lender can 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. Lending funds without holding collateral is riskier for the lender, which means that there is typically a higher bar to meet to have a chance of getting approved. To get approved, you will probably 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.
Should you get a line of credit? Understanding the pros and cons
Pros of getting a line of credit:
Flexible access: One of the primary 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. Unlike a term loan, funds from a line of credit are revolving, meaning that when you pay them back, you can use the funds again.
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 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 upfront. Some lenders will charge fees to keep your account open, charges 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 the 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 an excellent 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. Ask your lender if they do report back to credit bureaus; not all of them do.
Lower interest and lower fees: For some business expenses and situations, it’s often better to use a business line of credit than a business credit card, because business lines of credit typically have lower interest rates than business credit cards. 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.
This last “pro” comes with a few big caveats. There are lines of credit that are just as expensive as credit cards, if not more so. Even if a line of credit does not come with prepayment fees, they might front-load the fees, so you do not save as much by prepaying. If you are hunting for lower costs, it’s always wise to compare your options carefully before deciding.
Cons of getting a line of credit from a big bank
The application process can be complicated: While it’s not always the case, applying for a business line of credit from a major bank can be a slow, challenging process. It will most likely involve 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. If you need funds quickly, you may want to seek other forms of funding or other sources for your credit line that require less paperwork than banks typically do.
Fees add up: 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. You may want to try to negotiate a low rate of interest to account for such fees. You should at least be aware of them so you can avoid as many fees as possible.
Too much debt: One big challenge to keep in mind is accumulating debt. If you are unable to pay back the funds owed, you could find yourself in default with your lender. It’s easy to get into a debt spiral, so it's important to stay on top of your payments. If you can’t make your full payment, 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 want to avoid. To prevent this from happening, be honest with yourself about how much debt makes sense, and how you plan to repay it before you take on any new loan.
What are the requirements to get a business line of credit?
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 from a major lender. This is not a complete list and different lenders may have different requirements, but this will give you a good idea of what you might need to provide.
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. Sometimes a lender will tell a small business owner to pledge all of their assets to secure a business line of credit.
Business operating time: Most lenders will have a requirement that a business be in operation for a certain length of time before qualifying for a line of credit. Some lenders (such as major banks) may only consider businesses that have been in operation for at least two years. If the lender feels a startup has good collateral and sound personal credit, it may make a rare exception. Time in business requirements may differ from lender to lender, so be sure to ask.
Financial statements and reports: According to the US Small Business Administration and reported in USA Today, only 20 percent 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 to consider your business for a line of credit.
Profit and revenue: Your business should generate revenue to be eligible for a business line of credit. When you apply, chances are 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 may need 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 may 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
Debt service coverage ratio
Fixed-charge coverage ratio
Where can you 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 might 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 rarely go as low as $5,000.
If the business is less than two years old, certain banks may approve 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.
Learn more about SBA Loans in our guide.
Consider a Fundbox Line of Credit
It used to be that a major bank was one of your only options for getting access to a business line of credit, but not anymore. Business owners have many financing options to choose from, many of which are faster, easier, and more flexible than applying for a line of credit with a bank.
Fundbox is one such option. We’re a financial technology company built on the mission of helping business owners get access to growth capital so they can succeed. Since 2013, Fundbox has connected to over 500,000 small businesses. We’ve helped thousands of owners get access to flexible funds, up to $150,000.
Unlike a lump sum term loan, a Fundbox Line of Credit offers flexible access to funds you can use to optimize cash flow to cover expenses like payroll, insurance, marketing campaigns, and more.
How to apply for a Fundbox Line of Credit
You can apply online for Fundbox credit in two simple steps. Unlike a traditional business loan application, you will not have to complete any paperwork to get started, and you can get a decision in as little as minutes.
Applying is safe and secure and will not impact your credit score. Simply enter your business information and connect your business banking account to apply. If you’re approved, you could receive fund as soon as the next business day.
Who is eligible for a Fundbox Line of Credit?
To qualify for Fundbox credit, your business should meet the following requires:
Based in the U.S.
$100,000+ in annual revenue
6+ months in business
600+ personal FICO score
Business checking account