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How Does a Business Line of Credit Work?
Written By: Adam F.

A business line of credit is a valuable tool for your enterprise that can help streamline your finances and ensure that you have funds available when necessary.

A business line of credit differs from other common types of financing, like small business loans and credit cards, and may be available on more attractive terms and rates.

So how does a business line of credit work and is it a good option for your business? Let’s find out!

What is a Business Line of Credit?

A business line of credit is a fixed amount of money available to use when and if your business needs it.

For example, you may apply for a credit line of $100,000. Of course, that doesn’t mean you intend to use all the available money, but you will have quick access if you need it. In fact, those two features—flexibility and availability—are the biggest advantages of a business line of credit compared to other financing options. 

A business line of credit is very similar to a Home Equity Line of Credit (HELOC), but you don’t have to guarantee the loan with equity as you do with a HELOC. The similarity is in the structure. You can use as much or little of the line limit as you need, and your payments depend on how much you use. If you use a portion and pay it back, that amount is available for reuse as long as the line is in place. The limit of a business line of credit depends on several factors, including:

  • The size and revenue of your business
  • The length of time the company has been in operation
  • Your business credit history

If you have a new or very small business with little revenue, the financier may require your personal credit and financials to be approved for a business line of credit.

What is a Small Business?

A small business as defined by the Small Business Administration is a business with less than 1,500 employees and revenue under $40 million.

In the US, more than 99 percent of companies are small, according to the Small Business Administration. Depending on the industry, the definition may be based on employee headcount, revenues, or a combination of both. In common usage, most people describe a company with fewer than fifty workers as a small business.

What Can I Use a Business Line of Credit For?

There are many potential reasons for drawing on your line of credit. For example, you might need to pay an unexpected bill, take advantage of a new marketing strategy, or meet an emergency need for repairs.

But if you’re low on cash, these can be problems. Imagine if you are expecting a large payment from a customer, but they are late in sending it, and your employees are waiting for their paychecks. This could be a great time to draw from your business line of credit.

Suppose you run a business selling aftermarket accessories for high-end motor homes. You may have been operating for five or more years and have a full-time employee base of 40 people, plus some seasonal workers. Let’s say that you find an opportunity to buy a tool that would allow a huge productivity boost for your operation, but it costs $10,000, and there are a few other competitors interested. Unfortunately, you may not have time to apply for a loan, and you may not have $10,000 available. Instead, if you can draw $10,000 from your line of credit, you can quickly purchase the available item and enhance your operation.

With a business line of credit, you can access the funds with a transfer to your business checking account or a special credit/debit card that draws from the line of credit account. You will make payments based on the amount drawn and the interest rate charged. You don’t make payments or accrue interest until you use the available funds, although you might pay a setup fee or loan origination charge. 

Tapping into a business line of credit can be a great option for small businesses facing a cash crunch for a variety of reasons.

How Can I Get a Business Line of Credit?

If you have a relationship with a financial institution, you start there, but don’t assume that your bank will give you the best deal available.

It’s smart to shop around and compare interest rates, fees, and terms to find the best option for your business. Your lender will need plenty of information about your business, including its size, structure, and ownership. In addition, they will often require your tax returns and other financial statements. You should be able to obtain a line of credit whether the business is a sole proprietorship, a partnership, or S corporation. Remember, the rate you pay for the credit will vary depending on your businesses credit and finances, the lender you work with, and current market conditions set by the Federal Reserve.

Be especially vigilant about reviewing the terms of your financing. For example, the bank may reserve the right to increase your interest rate or reduce your credit line without notice. If you fail to pay another obligation on time or even if your revenues decrease, they may exercise this right. If they perceive a risk escalation, they will try to protect themselves first, which will often cost you more money. Another provision to look out for is a prepayment penalty. Most traditional lenders do not charge prepayment penalties, but some low-cost alternative institutions may.

With any funding method, you should review the terms and conditions of your financing and ask questions to your lender so you can be smart with your borrowing.

What’s the Bottom Line?

Access to affordable, flexible credit can make the difference between success and failure for any small business.

If you have a business line of credit, you are well-positioned to take advantage of opportunities as they arise, without waiting for a lending decision. You can cover unexpected expenses and ensure your employees are paid on time – without having to commit to a large lump sum of cash.

If you need flexible financing that won’t cost a fortune, a business line of credit is one of your best options.

Ready to find a business line of credit? Contact Llama Loan today to get started!

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