Business lines of credit are a popular commercial funding method. About 40% of small businesses in the U.S. apply for new credit each year. But not all of them get the funding they ask for.
Because of a lack of knowledge, mistakes in the application, or simply a failure to meet eligibility criteria, some applicants won’t qualify for a business line of credit.
That’s a problem. If your application is rejected, your business might struggle with cash flow issues.
You can use credit lines to cover everything from inventory purchases to operational expenses. When you have ample credit, you can pay for business costs when your cash flow is short because of unpaid client invoices or a slow sales period.
But to avoid rejection and ensure you get the proper funding, you need to know how to prepare your application. Business line of credit applications are relatively straightforward, but there are a few things you should know before getting started.
To help you on your journey, read this detailed overview of how to apply for a small business line of credit and what factors might stop you from getting approved.
What Is a Business Line of Credit?
A business line of credit is a revolving credit facility provided by a business lender that allows a business to access funds, via a draw, up to a credit limit. It provides flexibility for small businesses to borrow and repay funds at will, paying interest only on the outstanding balance and offering a continuous source of funds for operational expenses, inventory management, manage cash flow fluctuations or seize on time sensitive opportunities.
For example, let's say you have $100,000 in business credit with an interest rate of 10%. You use $70,000 as a bump for your cash flow, so you have $30,000 remaining.
You won’t pay back the total $100,000 limit with a 10% interest rate. Instead, you start paying back the $70,000 you borrowed, and you pay interest of 10% on the balance. That means, if you keep your balance low, you’ll be able to keep your interest charges and repayment amounts low as well.
If you’re ready to apply now, click here to apply for a business line of credit!
Business Term Loan vs. a Business Line of Credit: What’s the Difference?
Small business loans or business term loans are very different from business lines of credit. When small business owners get business loans from traditional banks or online lenders, they get a lump sum that they need to start paying back with interest.
So if you get a $100,000 loan at 10% interest, you will start making fixed repayments on that amount right away. Also, as you repay the debt, you can’t keep drawing down funds.
A line of credit gives you an available limit to use. Translation: greater flexibility.
With a $100,000 credit limit, you pay back the money you withdraw, not the full limit. This is similar to how financing works with business credit cards. As such, you can potentially have a lower monthly payment with business lines of credit.
You can also keep drawing down your balance as you repay what you spend, as long as you don’t go over your limit.
One key difference to keep in mind: lines of credit tend to have higher interest rates than term loans. That’s why they’re best suited for temporary cash flow relief. You can use the credit to cover purchases and then pay back what you spend in a timely manner to avoid paying a lot in interest.
When Not to Apply for a Business Line of Credit
Business lines of credit, just like business credit cards, are a great way to manage cash flow and cover day-to-day expenses. You can use it to cover fixed costs, get more working capital, pay salaries, pay business taxes, and more.
But because it often comes with a higher interest rate than a term loan, there are times when you’re better off not applying for a business line of credit and getting a term loan or other funding instead.
If you need to hire more people, you’ll probably need to borrow a large amount upfront. The same goes for purchasing high-value equipment or technology.
In these cases, you know you need a large lump sum to start, so you wouldn’t necessarily want a business line of credit because you might have to use most of it right away. And with a higher interest rate, your business credit can get very expensive.
That’s when a business loan comes in handy. You apply for the amount you need and then repay the debt for a set amount of time. Once it’s paid off, you’re done. There’s no more funding and no more debt.
How to Apply for a Business Line of Credit
If you’re ready to apply for a business line of credit and submit an application, you should follow these steps to ensure you have the right documents and application information.
Step #1: Choose a Business Line of Credit Provider
Various financial institutions offer business lines. Depending on which institution you go to and how much funding you need, you will get different conditions and interest rates. You can apply for lines of credit from banks, credit unions, and online lenders.
a. Banks and Credit Unions
Banks and credit unions are traditional business funding providers. They usually offer both a secured line of business credit, which has to be backed by collateral, and an unsecured business line of credit that does not require any collateral.
But because these institutions are more traditional, bank business credit lines tend to have strict eligibility requirements, making it harder for some small businesses to qualify. However, if your application is accepted, you’ll probably pay a lower interest rate.
In terms of collateral, these institutions will offer lower credit limits for unsecured business lines, so you will most likely have to provide collateral if you want a large limit.
b. Online Lenders
If you want flexibility, convenience, and more relaxed criteria, online lenders are a better option. They have laxer eligibility requirements and offer flexible financing, which makes them ideal for startups that barely meet the minimum credit score requirements or are still looking to build business credit.
These institutions also process applications quickly, and you may get your line of credit within a few days after applying.
But, online lenders typically charge higher interest rates because they are taking on more risk by offering more flexible lending terms.
Step #2: Fill Out the Application
Once you decide which financial institution to use for your application, it's time to start the process. Banks, credit unions, and online lenders all require a completed form to initiate the application.
These forms are most likely available online, but you can also access them by visiting the bank or credit union or speaking to their representatives on the phone or via email.
Application forms require you to provide basic information about you and your small business. You will need to write up information such as:
- Business name
- Business address
- Business contact information
- Services or products you sell
- The industry you operate in
- Number of employees
- Personal information of owners
- Social Security number (SSN)
- Business Tax ID
- Annual revenue
- The reason you need a credit limit
- The amount of money you need in your business credit line
When filling out the application, take great care to provide the correct information and not make any mistakes. Once you’re done, submit the application and wait a few days for a representative to contact you and continue the process.
Step #3: Submit Supporting Documents
The next step is the most critical part of the application process for lines of credit.
When a representative contacts you to discuss your application, they will also ask for supporting documents and information. They will send you an email or letter specifying what documents they need from you personally and on behalf of your business.
a. Personal Credit Score
Even though you're applying for business funding, the financial institution needs to make sure you, as the small business owner, are in good financial shape. So you’ll need to give the lender permission to check your credit report.
If your business cannot meet its financial obligations and pay back the line of credit, then you might be responsible for covering it with personal assets.
To prove your financial well-being, every institution will have a minimum credit score you need to meet. This depends on their requirements, but most lenders will consider a score of 680 or higher to be good enough.
That doesn't mean you won't get the business line of credit if you don’t meet the minimum credit score. It just means that it might be more difficult, or you may have a higher interest rate.
b. Business Credit Score
Similar to your personal credit report, the lender will also need to look at your business credit report. This report will show your business's performance when dealing with other financial obligations, such as other loans, business credit cards, and merchant cash advances.
c. Business Financials
The lender will also review your business financial statements. These statements provide a detailed picture of your business's financial health.
With most applications, you will have to submit these financial statements:
- Balance sheet
- Income statement
- Cash flow statement
The bank, credit union, or online lender will look at your revenue and profits and calculate various ratios — debt to equity ratio, current ratio, fixed-charge coverage ratio — to determine if the business is likely to meet all its obligations.
d. Time in Business
Young businesses and startups have a very high rate of failure, especially in the first two years of operations. That's why they are considered riskier. The reality is that most funding institutions will be wary of providing financing to newer businesses.
For a business line of credit, you might need to submit documents that prove you have been in business for more than two years. This includes documents such as:
- Business tax returns
- Business license
- Articles of incorporation
- Building lease
- Business plan
If you have been in business for less than two years, don't worry. You can still get a line of credit, but with stricter rules. For example, most institutions will require collateral and refuse to grant you unsecured lines. You will also be charged higher interest rates.
e. Availability of Collateral
Unsecured business lines do not require collateral. But you have to be in a strong financial position to get an unsecured loan. If you are a new startup, have a lower credit score, or do not meet eligibility requirements, the bank or online lender might offer you a secured business line of credit with collateral instead.
Collateral is a business or personal asset that has roughly the same value as the amount you are asking for in a line of credit. For example, collateral can be a piece of real estate, a car, or other high-value assets.
If you or the business cannot afford to pay back the credit line, the lender has the right to seize your collateral.
If you are planning to offer collateral, you need to submit documents such as:
- Valuation of the collateral
- Proof of ownership by you or the business
Step #4: Wait for Processing
After submitting your documents, the lender will process your application.
They will consider all the information and documents you submitted to determine if you meet the criteria for a line of credit. All you need to do during this time is answer any questions the lender has and provide additional documents if required.
Step #5: Get a Response from the Lender
After evaluation, the lender will provide an answer for your application through a phone call, email, or notification on the application platform.
If you got approved for a line of credit — congratulations! Read the line of credit agreement carefully before signing it in case there are clauses that still need to be discussed with the lender.
If you didn't, then inquire about the reason you were rejected and see if there is a way to salvage the application.
Step #6: Use Your Business Line of Credit
If you get approval on your business line of credit, you can start using it immediately. Withdraw the funds you need and use them for managing cash flow, purchasing supplies, and other costs. Just beware that when you withdraw funds from your line of credit, you will have to start making monthly payments.
Why Your Application for a Business Line of Credit Could Be Rejected
If you don’t get approved, it could be because of one of the following reasons:
1. High Industry Risk
One reason your application for a line of credit could be rejected is industry risk. For example, hospitality and other seasonal industries are viewed as higher risk than grocery stores and manufacturers, which tend to have stable revenues.
If the reason for rejection is this risk, there are a few things you can do. One of the best ways to counteract this rejection is by offering collateral, if available. Another way is to demonstrate that you, as the business owner, have a strong financial situation and can pay back the credit line if the business is unable to.
2. Not Enough Collateral
If you do not have enough collateral to put toward your line of credit, more traditional institutions, such as banks or credit unions, may reject your application.
In this case, you can agree to a higher interest rate in exchange for approval. Or, you can demonstrate the business's or your strong financial situation through detailed financial statements — the goal is to assure the lender that you won't default on your line of credit.
3. Low Credit Score
A low credit score can be damaging, but if you get a rejection because of it, there are still ways to salvage the application. You can do things such as:
- Accept a higher interest rate
- Provide collateral
- Demonstrate the financial strength of your business
- Provide proof of your own strong financial situation
4. Not Enough Time in Business
Finally, if you are a new startup with under two years of business operations, you have a high likelihood of being rejected. To counteract this, you can:
- Demonstrate your strong business performance with financial statements
- Provide proof that you as the owner can cover the line of credit in case the business is unable to
- Offer collateral
What Fees Can You Expect After Getting Your Business Line of Credit?
Some of the fees you can expect to be charged after getting a line of business credit are:
- Origination fee: The necessary cost for the institution to process your application
- Account maintenance fee: A monthly or annual fee to cover the cost of managing your account and keeping an active business line of credit
- Draw fee: A fee charged every time you draw funds from the credit line
- Inactivity fee: A fee to cover the cost of you not drawing funds from your line of credit for a specific period of time
You will see these fees in your line of credit agreement. Look for them and make sure you’re comfortable paying them before agreeing to the loan.
A business line of credit is useful for improving the day-to-day operations of your business. You can draw funds from it like a business credit card and only pay back the amount you borrow.
While a business line of credit can be a practical funding solution, there are plenty of other options out there that can help your business enter the next phase of growth.
To better understand your choices, a business funding marketplace is the best place to start. AdvancePoint Capital provides small businesses with detailed comparisons of their funding options and allows you to apply in minutes and get funding in days.
Get a quote for a business line of credit today!