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Should I Take out a Business Line of Credit?

Marcela OteroJun 22, 2017

Extensive research has proven that small businesses, particularly new and growing concerns, often provide the most consistent growth patterns to the economy. Unfortunately, since the 2000s decline in economic activity, banks and traditional lenders have been steering away from small businesses, instead favoring larger, more established firms. There are still many different ways that small business owners can obtain financing for their operational needs, however. One of the lesser known of these is the business line of credit.

What Is a Business Line of Credit?

A business line of credit is a specified amount of money that an individual can access as needed and then repay either immediately, or over a pre-specified period of time. Lines of credit are revolving accounts generally unsecured by collateral. This means that borrowers can spend the money, repay, and then spend it again, in a virtually never-ending cycle.

How Business Lines of Credit Work

Business lines of credit provide flexible, revolving capital in a way that regular business loans don't. As it is a loan, borrowers must pay interest on the money borrowed, but not on the remaining available balance in the credit line. 

When Business Lines of Credit Make Sense

Lines of credit address the fact that most lenders aren't willing to give out loans every couple of months, particularly not ones that are unsecured, but businesses may need periodic infusions of cash. Business lines of credit serve to smooth out the inconsistencies many small businesses have in monthly income vs expenses, and/or to finance projects in which it may be difficult to ascertain the amount of upfront funds necessary. They can help manage cash flow, buy inventory, and pay for surprise expenses. 

If you and your business have solid credit, good revenue history, and have been operating for at least 6 months to a year, a business line of credit can be a great choice for obtaining financing quickly and inexpensively. This type of debt instrument can even better your credit score, provided you make payments on time and keep a low balance. This consistency gives you the opportunity to build yourself into a reliable borrower. 

Since funds can be accessed instantly once approved, lines of credit are available immediately for any unforeseen emergency. Having one as backup, even when rarely used, can provide enormous peace of mind. As long as business owners take care to not tie these funds up in long-term investments, and remain diligent in their payment schedules, lines of credit are excellent resources. 

Business Lines of Credit vs. Business Credit Cards: Is There a Difference?

Two popular ways for small businesses to obtain quick access to funds is through lines of credit or credit cards. Both are usually easier to qualify for than traditional loans. This is especially true for young or small concerns. Since business lines of credit and business credit cards work in almost exactly the same way, let's focus, rather, on the differences between them.

Business Credit Cards

Though credit cards are very widely accepted forms of payment, interest rates can be a lot higher than for a term loan. These can be avoided, however, by always paying statement balances in full. One advantage of credit cards over lines of credit is that you can obtain rewards for your business spending in the form of points, miles, and cash back. In fact, business credit cards will likely offer bonus rewards for the types of purchases companies most make, such as telecommunications service providers or advertisers. 

On the other hand, cash advances can be prohibitively expensive. This can be an issue, since not all billers accept credit payments. Additionally, approvals are also heavily tied to a borrower’s personal credit score, so it may be difficult to gain approval or higher limits.

Business Lines of Credit

These can be great tools when providers don't accept credit cards, as they can be used to access both checks and cash. Payments are interest-only, and there are no fees for cash advances. Since it relies mainly on your business' credit, it can be a good way to build a strong credit profile for your company. Interest rates can be substantially lower than for a business credit card, repayment can also be more flexible, and they may have less associated fees and charges. Though some lenders assess a maintenance fee for unused lines, many don't.

One disadvantage to a business line of credit as compared with credit cards, is the fact that they don't accumulate bonus points or rewards. It may also require collateral, depending on the lender. 

Pros and Cons of Credit Lines

Just as any other debt instrument, credit lines can be both advantageous and potentially dangerous. Their supreme flexibility can make it easy for business owners to undertake one without fully understanding their company's opportunities or ability to repay the borrowed sums. Borrowers in need of large sums of money for longer time periods, for instance, would be better served by a small business loan. 

Pros Cons
Flexibility High risk factor if business underperforms
Interest is only owed on funds borrowed May require annual, opening, or transaction fees
Access to unsecured funds May have strict requirements, depending on the lender
Possible increase in business credit rating, when managed correctly Application process can be difficult with traditional lenders

Smaller lines for new businesses

Who Qualifies for a Business Line of Credit?

Traditional, bank-issued business lines of credit call for a substantial amount of documentation in order to qualify, such as financials, personal tax returns, business tax returns, bank account information, business registration documents, etc. Their interest rates are competitive, at between 5% and 13%.

Non-traditional financiers, such as online lenders, generally have less stringent qualifying requirements, approval times are quicker, and they offer greater flexibility. Online lenders tend to be substantially more expensive than traditional ones, with APRs around 20%-40%. They generally don't need collateral, as opposed to banks, which ask for either hard assets or short term sources, such as receivables. 

Some bankers and online lenders who participate in the SBA 7(a) loan program also offer SBA CAPLines credit lines which have limits of $5 million and correspondingly high requirements. 

Requirements: Banks vs. Online Lenders (numbers are estimates, and can vary according to individual lenders)

Banks Online Lenders
Credit Score 680+ 600+
Time in Business 24+ months 12+ months
Revenue Required $10k+ in monthly averages $100k in annual revenues
Collateral Hard or short term assets Short term assets (not as important as with banks)
Credit Line Amounts $10k - $100k Up to $100k

Independent of the lender you choose, there are a few things you can do to help your chances. Try and apply when your credit score is high and while revenues are up. If you already have a credit line, whenever you've met a benchmark for credit score, gross revenues, or time in business, it's a good time to apply for an upgrade. Lastly, another good idea is applying in advance of when you anticipate a capital need. Though it may seem counterintuitive to apply for money when it's not needed, this may be the precise time to think strategically.