Small Business Line of Credit: How to Choose the Right Option

Small Business Line of Credit: How to Choose the Right Option

Small Business Line of Credit: How to Choose the Right Option

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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?

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.

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

Line of Credit by Fundbox

The Fundbox Line of Credit is a common sense approach to small business funding, with Learn More

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.

This article was originally written on August 8, 2018 and updated on November 17, 2020.

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Gerri Detweiler

Education Director for Nav

Gerri Detweiler is Education Director for Nav. Known as a financing and credit expert, she has been interviewed in more than 4000 news stories, and answered over 10,000 credit questions online. Her articles have been widely syndicated on sites such as MSN, Forbes, and MarketWatch. She is the author or coauthor of five books, including Finance Your Own Business: Get on the Financing Fast Track. She has testified before Congress on consumer credit legislation.

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9 responses to “Small Business Line of Credit: How to Choose the Right Option

  1. I have a question…how can a start up business get a loan for 10 or 20,000 if they have no revenue to show, or no business credit built-up? I am so confused about what is said when you have a business but its really based on your PG. It should be told that you will not succeed unless you have good credit and if you do not then prepare to not establish business credit for about 6 to 8 months after opening. There should be loans to where it can boost you regardless of your credit

    1. A start up loan with no business revenue or time in business is extremely risky for the lender. If there is no personal guarantee the lender will have no recourse to collect if the business fails and many small businesses do. That’s why many lenders will require a good personal credit score and personal guarantee from the owner until the business has established strong business credit, revenues and time in business. That said there may be options. Have you seen our video on start up financing?

  2. Do you know of any lenders that will extend a line of credit to a Tech start-up company? I’ve been in business for over three years.

    1. Walter, Lending environments are changing daily. You can set up a call with our Credit & Lending Specialists – just keep in mind they are booked out right now due to demand for the SBA Cares Paycheck Protection loans. But we’ll help as soon as we can!

  3. What companies and/or BLC’s do you recommend for persons wanting to do fix’n’flip rehabs in real estate, where $200,000 can be bought for half or less of ARV, repaired with minimal investment , then sold at or near full market value?

    1. Benton, Nav offers a free lending marketplace where we work with a variety of lenders. You can check it out with a free Nav account (which won’t affect your credit scores). If you have any questions about your specific options you can always talk with our Credit & Lending team. Many of our Nav customers are involved in real estate.