When it comes to operating a small business of any kind, financial challenges and hardships are common. In fact, 20% of new businesses close within a year of opening.
That’s where a business line of credit can help.
With a business line of credit, you can get access to funds that can help alleviate cash flow challenges so you can focus on growing your business.
Ready to learn how to get a business line of credit and how it can help your business? Let’s find out!
A business line of credit is similar to a traditional loan, but in many cases, they can be a stronger option.
A line of credit allows you to meet unexpected financial needs without obligating yourself to significant payments that come with conventional loans. For example, suppose you obtain a line of credit with a limit of $150,000. If you don’t use any of the funds, you aren’t forced into making payments like you might be with other financing methods. If you use a small amount, your payments are based only on how much you use. Even better, when you repay what you have drawn, it is available for re-use, if necessary.
Let’s consider an illustration:
You obtain a $150,000 line of credit for your business. One month, you experience a cash flow issue and need to use $10,000 from the line to meet payroll. All is well, and you begin making payments on the amount you used. Then, suppose you learn about the opportunity to expand into a bigger location in a few more months, and you need $40,000 to finance the lease and finance the move. Now the payments are bigger because you have used more of the available funding.
But you still have a cushion of $100,000 for other needs if they arise. And after you pay back part of the $50,000 you have spent, that gets added back into the available credit line.
Many financial institutions like banks, credit unions, and online banks offer lines of credit for businesses, but these aren’t always the best options.
Start by talking to a lending officer at your local bank, but don’t assume they will offer you the best rates and terms. Various banks and other lenders set product terms based on their preferred products. That means if a particular institution is concerned about the risks of car loans, for example, they might offer a slightly higher interest rate for car loans than a competitor. If that same bank has more confidence in housing, they might set their mortgage rates at a more favorable level. That’s why it often pays to shop around and consider using a loan broker to compare options.
When you start the process, one of the first things you need to consider is whether you are looking for secured or unsecured line of credit.
Secured credit requires you to provide collateral to the lender, which gives them recourse to recover their money if you default on the loan. For example, you secure a home mortgage using the property, which is why it’s difficult to obtain a mortgage for more than a property’s appraised value. Likewise, vehicles can be used as collateral for personal car loans. Other personal loans and most credit card debt is unsecured, which means the lender has to collect funds from you, which can be much more challenging, if not impossible which explains why unsecured credit comes with higher interest rates and fees.
If you apply for a secured line, you will need to offer collateral plus all the other financial information the lender requests to consider your application. Typically, the lender needs your personal credit information, although that depends on the size and longevity of your business. In addition, you will need to provide details about your company’s revenue, age, and other financial statements.
If you own the property your business occupies, that is one good source of collateral, as is an expensive piece of equipment (as long as you own it, but not if you are still making payments.) The upside of a secured line is that typically the lender can offer a lower interest rate and less expensive fees thanks to the lower risk than it would be with an unsecured line of credit.
As with many financial situations when applying for credit, the documentation required for a business line of credit can seem extensive. Prepare for the lender to ask for many of these items:
You should also be prepared to specify the amount of credit you want. Remember that the better your company and personal credit score, the more likely you will get approved and receive a favorable interest rate. While proceeding through the application process, be responsive to your prospective lender’s requests for additional information or clarification. Promptly providing requested information and documentation can help to expedite the process and get access to funds much quicker.
Unlike a traditional business loan, your line of credit usually isn’t designated for a specific purpose. You don’t have to tell the lender what you intend to do with it (even if you know.) You may want to have it available in case of emergency, for peace of mind to protect against an income interruption, or to access when a great opportunity presents itself. The great thing about a business line of credit is that you only make payments if you borrow against it, and your payment varies according to how much of the line you have used. If you don’t need it, you aren’t paying for it.
With that in mind, requesting a little more than you think you need may be a great idea. Just remember not to be careless about spending. Like a personal credit card or other lines of credit, spending more than you intend is easy, and it can be costly. So be cautious, and you can ensure that you have the funding you need when the time arises.
Opening a business line of credit can be a great way to help manage your cash flow and have quick access to cash when needed.
They work similar to a business credit card in that you’ll only pay interest on the amount you use, rather than a large lump sum.