Getting a small business off the ground is no small feat. As you continue to grow and reach new goals or greater revenue levels, you'll likely require funding to improve working capital and further build your business.
Loans or a line of credit can be excellent choices to boost working capital, improve cash flow, purchase inventory, or cover other essential business needs for your company. However, a business line of credit is one of the best funding tools for small businesses because of its unique benefits.
What Is a Business Line of Credit?
Now, you might already be familiar with lines of credit. However, if not, don't worry; we offer a thorough description of how it works right here so you can decide what's best for your business needs. Now, let's take a look at the ins and outs of a business line of credit, plus its benefits, below:
How It Works
Essentially, a business line of credit works like a regular credit card, with a few minor exceptions. So, you can draw on the allotted amount of money from your lenders up to a specific credit limit. A line of credit and a credit card are similar because a line of credit and a credit card are both revolving credit facilities that allow you to borrow at will up to a credit limit with payments based on your balance and interest charged. Both allow you to draw up and pay down on demand without penalty.
But, the primary difference is how you are allowed to utilize the funds. Credit cards have many more limitations on how, where, and when they can be used compared to a credit line. For instance, certain payments are only possible using business credit lines and not a credit card, including:
- Property leases or rent
- Vendor invoices
- Other significant short-term purchases
Unlike other business loan products, such as short-term loans, you don't receive a lump sum of money upfront. Instead, you are allotted a certain amount to spend up to your limit. Plus, you aren't required to disclose the use of your funds when applying, like with other loan products. For this reason, business owners have much more flexibility when utilizing the cash flow infusion.
Fortunately, with a business line of credit, you only have to pay interest rates on the funds you use. After your balance is repaid, your spending allowance is replenished once again. Sometimes, you'll hear this funding option referred to as a revolving line of credit for this reason.
Secured vs. Unsecured Lines of Credit
Like other loan options, your business line can be secured or unsecured.
Secured lines of credit require collateral or a personal guarantee to prove your ability to make payments. Collateral is liquid or tangible assets lenders utilize to ensure they're covered if you default on a business loan or don't repay what you owe.
In contrast, unsecured lines are obtainable without any collateral. However, you may offer a personal guarantee, essentially a promise to repay the money from your line of credit even if your business defaults.
Of course, offering collateral when applying for a loan or line of credit gives lenders more security, hence the name. Thus, the terms, costs, and fees are far better with an unsecured credit line. However, an unsecured line of credit can still be a massive asset to a small business, especially if the company or its owner has a poor credit history.
Acceptable Forms of Collateral
If you can offer cash, liquid assets, or other guarantees to acquire a line of credit! Here are a few examples of what you can provide to outlets like SBA-approved lenders to obtain financing for your small business:
- Cash assets
- Personal or commercial real estate
- Unpaid invoices
- Equipment or vehicles
- Blanket liens
As the saying goes: cash is king, which holds when using money as collateral for a loan or line of credit. Generally, lenders like to see that you have genuine assets and cash.
Can Small Businesses Qualify?
Put simply, yes! Lines of credit are a choice for your small business for many reasons. However, before you can utilize the freed-up capital from this product to meet short-term goals, you need to understand better what's required to apply and, more importantly, qualify.
What You Need to Qualify for a Business Line of Credit
Each lender will have a different set of minimum qualifications your business must meet to receive a line of credit. Personal scores, business scores, annual revenue, and your time in business are essential to your approval. Basic qualifications include:
- Being in business for at least six months
- A personal credit score of at least 600
- Available business credit bureau scores
- An average of $200,000 in annual revenue
While online lenders are more flexible with their qualifications than traditional lenders, it’s essential to know that you still need to provide basic information – like the above – to show creditworthiness and be eligible. Additionally, lenders may request that you provide more information when determining your eligibility, such as:
- Business bank statements
- Profit and loss statements
- The past few years’ tax returns
- Accounts payable and receivable
- Balance sheets
Benefits of a Business Line of Credit
Lines of credit offer several excellent benefits to small businesses. Let's take a look:
The primary benefit of a business line of credit is its flexibility. Since it helps maintain your cash flow, you can utilize the newfound working capital to cover various business expenses, just like a typical card. And when you’re a small business owner, what could be better than that?
Lines of credit are known for their renewability since you can continuously draw on replenished funds after making your payments. Typically, terms and costs are restructured annually or semi-annually.
3. Lower Interest Rates
Even unsecured lines are relatively short-term and low-risk for lenders, so they often come with great interest rates. Online lenders are especially renowned for offering the lowest interest rates on financing for business lines, but fees and rates can always vary by lender.
4. Improves Cash Flow
Although you're not receiving a lump sum upfront like other loan options, lines of credit can still help improve cash flow. They give you fast access to working capital, which can be crucial during slower seasons when stocking inventory pre-holidays or meeting short-term growth goals.
5. Builds Business Credit
Business lines are also an excellent way to improve your business credit or start building it all together. If you make payments on time and stay within your credit limit, your credit score should continue rising.
6. Covers Hidden Expenses
You can also use a line of credit to cover emergencies or unexpected expenses. For example, the money can go towards new equipment or repairs, replacing an employee, or other immediate business needs. Or, you can put the funds towards payroll since failure to compensate your staff is unacceptable.
7. Funds Short-Term Goals
Another reason many businesses choose this option is to pay for short-term business goals that can help foster further growth. Although they might seem like minor investments, these small actions can vastly improve your business, and lines of credit make it possible. Examples of short-term business goals often include:
- Implementing advertising
- Hiring personnel
- Developing new products
- Updating facilities
8. Can Be Unsecured
As mentioned above, lines of credit can either be secured or unsecured. For this reason, lines of credit are an excellent choice for businesses lacking adequate assets for a secured loan or credit line.
9. Offered By the SBA
One last great benefit to business lines is that they're offered through Small Business Administration (SBA) loans and several other loan and financing options. Your small business can apply for lines of credit through the SBA’s CAP Lines program via approved lenders, who typically offer excellent rates with minimal fees. However, the Small Business Administration has lengthy application processes and approval times. Don't expect access to working capital within hours or days as you can get with online lenders.
How To Use Line Of Credit
A business line of credit functions as a revolving credit facility that allows a business to draw funds online or app on demand up to a credit limit. You can also pay down your balance online or using an app. The credit line can be used for any legitimate purpose. The business only pays simple interest on the balance, not the credit limit, and can be paid off early to save interest with no prepay penalty.
What can a business line of credit be used for? You may ask. A line of credit is commonly used for working capital to cover various purposes, such as unexpected expenses or emergencies, maintenance and repairs, shortfalls or cash flow fluctuations, or urgent purchases. It can also be utilized for improvements or expansions or any legitimate business purpose.
Drawbacks of a Business Line of Credit
Like any other funding product, a business line of credit comes with some risk. If your business folds, you're still personally liable for repaying what you owe, even after dissolution. Failure to repay the outstanding debts can result in a significant hit on your credit score.
Additionally, since it's similar to a credit card, there is always a chance for misuse. For example, lines of credit can be excellent for covering hidden expenses, but abusing them or exceeding your credit limit can financially put your small business in some serious hot water. As such, keeping your spending under control with a business line of credit is crucial.
Even with these few drawbacks, a business line of credit is still an excellent option for your small business for several other reasons, as listed above.
Obtaining a Business Line of Credit
Small businesses can take multiple routes to receive the funding they need. The financing options are virtually endless between traditional banks, local credit unions, and online lenders. You can even receive a business line of credit from an SBA-approved lender, although the application process is more lengthy than alternative lending outlets.
While banks and credit unions might seem like your best bet, they often have more stringent eligibility requirements or a higher interest rate. Instead, many small business owners go with online lenders like AdvancePoint Capital to find the best rates for a business line of credit.
Typically, online lenders are more relaxed with their paperwork, credit requirements, and other eligibility guidelines. For this reason, it's much easier for a small business to get approved for a business line of credit through an online lender.
Is a Line of Credit the Right Choice for You?
The short answer to the above question is always yes. For instance, what business owner would pass up access to revolving capital to cover emergency expenses or continue to grow their company?
With all the excellent benefits a business line of credit offers, applying for a credit line with your chosen lender is a no-brainer. Fortunately, if you're still unsure where to start, AdvancePoint Capital can help you find the best financing tools for your business needs. Contact us today!