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A small business line of credit helps entrepreneurs maintain consistent access to borrowed capital to keep up with recurring expenses and the ebb and flow of seasonal changes in business. For the 50% of businesses owners who have experienced cash flow problems, a small business line of credit can be necessary to maintain regular business operations.
You may be thinking: “My business is profitable, we don’t need additional cash reserves.” But many businesses with and without cash flow issues keep a line of credit handy for unexpected growth or expansion opportunities. A business credit line is a flexible, often low-cost way to cover short-term financing needs regardless of the nature of those needs.
Business line of credit basics:
- How does a business line of credit work?
- What is a secured vs. unsecured business line of credit?
- What are lines of credit typically used for?
- Business line of credit requirements
- Best business lines of credit
How does a business line of credit work?
A business line of credit is a flexible loan option for businesses. It is also called a revolving line of credit. Businesses are allocated a specified maximum amount of capital available to them through a lender based on certain factors such as cash flow and business credit rating. A line of credit is similar to a credit card in that you can access your credit line, make repayment, and access the credit line again.
Unlike a business loan, which is distributed in a lump sum and a fixed periodic payment, a line of credit is repaid when the business draws from the line. Interest is only charged for the amount of the credit line that is accessed. The business decides when, if, and how they will use that borrowed capital. There will be a specified repayment period, but, like a credit card, there is no penalty for paying early.
Although interest is only charged on the amount of credit accessed, depending on the lender, there may be a monthly maintenance fee for letting your line of credit sit unused. For any line of credit you consider you need to carefully read the terms offered to make sure you understand any fees that may be included.
What is a secured vs. unsecured business line of credit?
With a secured line of credit the borrower puts up collateral as a security deposit on the line of credit. Putting up property as a form of collateral is common, but this could also be other assets owned by the business, such as equipment or inventory.
Secured credit lines may be preferred over unsecured lines by traditional financial institution like a bank or credit union. The lender is taking on less risk, so they may grant a higher credit limit at a lower interest rate for a secured credit line. New businesses or businesses with poor business credit might only qualify for a secured line of credit because of the inherently higher risk associated with a shorter track record or a weak credit profile.
In contrast to a secured line, an unsecured business line of credit does not require specific collateral. Unsecured lines of credit can be more expensive because the lender assumes higher risk. Credit cards are a type of unsecured line of credit. Businesses with many years under their belts and stellar business credit reports are more likely to qualify for unsecured business credit lines at reasonable rates.
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What is a business line of credit used for?
If you are looking to fund a one-time project or a very long-term project, a business loan might be a better fit for you than a business line of credit. Here are a few ways you might use a business line of credit:
- Your business has seasonal fluctuations—perhaps your sales take a dip in the summer.
- A line of credit will help during periods of low sales.
- Your clients take 30 days or longer to pay you for products or services you provide. You might need a line of credit to cover the interim time until you are paid.
- You land a huge client and need extra capital to cover the cost of materials while you ramp up work for the client. A line of credit can cover expenses during production.
- You have the opportunity to receive a discount if you pay a particular bill early—if the resulting discount is significant, you can cover the bill with your line of credit while you wait for cash flow to catch up.
What are the requirements to qualify for a business credit line?
A lender will look at your time in business, your personal credit score, annual revenue, the strength of your cash flow and the strength of your business credit to evaluate your business’ creditworthiness. If you don’t yet have a bank account set up for your business, and if you are not yet building business credit, it will be necessary to even be considered by most lenders.
In addition a traditional lender will look at is your ability to secure the line. Again, a secured line will likely be a less expensive option, so if you can collateralize the line of credit, it may help you with some lenders.
Similar to most financing options, the best time to get a line of credit for your business is when your business has healthy revenue and cash flow—rather than when your business is in a cash flow crunch. You’re more likely to qualify for the best terms when your business is in good financial shape and has no cash flow problems.
Remember: you’re only charged interest on the amount you borrow. If you secure a line of credit now you’re not obliged to use it, but it will be there when your business needs some extra capital.
Best Business Lines of Credit
Fundbox: Best option for startups
Fundbox has one of the least strict time-in-business requirements. You only need to be in business for 3 months to be considered for a Fundbox line of credit. You will have to meet other requirements—your business needs to have a business checking account and at least $25,000 in annual revenue. Fundbox business lines of credit are available up to $100,000.
See Which Business Line Of Credit Your Business Qualifies For
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