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

You may be thinking: “My business is profitable, we don’t need to borrow.” 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 get short-term financing to cover working capital needs.

What is a Business Line of Credit?

A small business line of credit can help small business owners maintain consistent access to funds to smooth out the ebb and flow of changes in business expenses and revenues.

Rather than receiving a fixed amount of financing like you would with a loan, a line of credit gives you access to a certain amount of money, which you can borrow from, repay, and borrow from again.

Business Line of Credit Basics

In this article, we’ll cover several aspects of a business line of credit, including:

How Does a Business Line of Credit Work?

A business line of credit is a flexible loan option for businesses. It may also be referred to as a revolving line of credit. You’re familiar with a line of credit if you use a credit card. It allows you to access funds from your credit line, pay back some or all of it, and access it again. With a line of credit, the business owner decides when, if, and how they will use that borrowed capital.

Interest is typically only charged for the amount of the credit line that is accessed, and interest rates may be fixed or variable. Variable interest rates typically change when interest rates in the economy change. Some lenders charge a draw fee every time you access the credit line.

In addition, there may be an origination fee, annual fee and/or a monthly maintenance fee if you don’t use your line of credit. 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 charged.

There will be a specified repayment period, but payments will vary depending on the amount borrowed. With some lines of credit (especially those from traditional banks), there may be a draw period during which you can access funds and make interest-only payments. After that, the business owner may enter a repayment period during which the outstanding balance must be repaid over a specific period of time.

Online lenders, on the other hand, often typically offer short-term lines of credit that fully amortize (or must be paid back) over a shorter time period, often 6-24 months.

Pros and Cons of Business Line of Credit

A line of credit can give you access to capital when you need it, but there are drawbacks to consider as well.

Pros

If you have the opportunity to, for example, expand your business, a line of credit affords you the opportunity to take advantage of it. Likewise, you can get the working capital you need to pay the bills during a slow period.

For many businesses, their financing needs aren’t adequately met with a large lump sum. Let’s say you’re renovating your commercial space. You might need $50,000 now, $7,000 in six months, and another $12,000 next year. A line of credit lets you get the cash you need when you need it rather than paying interest on money you won’t need for a while.

Cons

Just like with any financing, you’ll have to pay it back. If you don’t budget in that monthly payment, you may struggle to pay it, which puts you at risk of defaulting on the loan. If you made a personal guarantee, you’ll also risk your personal assets being seized if you can’t pay the loan.

Depending on what type of financing you qualify for, you may end up paying higher interest rates. If you run a startup that hasn’t been in business for two years or doesn’t have a strong credit profile, you may not qualify for the best terms.

Benefits of a Business Line of Credit

Here are a few examples of scenarios where your business may benefit from  a business line of credit:

  • Your business has seasonal fluctuations—perhaps your sales take a dip in the summer or winter, for example. A line of credit will help during periods of low sales.
  • Your clients take weeks (or longer) to pay you for products or services you provide. You might need a line of credit to cover business expenses while you wait to get paid.
  • You land a new client and need extra capital to cover the cost of labor and/or supplies. A line of credit can cover expenses during production.
  • You have the opportunity to purchase equipment or inventory at a reduced cost. You can cover the bill with your line of credit while you wait for cash flow to catch up.

Depending on the type of loan or line of credit, your creditworthiness may be a major factor in determining eligibility. The higher your credit score, the better the terms you’ll get.

If you’re concerned you won’t get credit approval, look for loans that consider your annual revenues more than credit.

How to Get a Business Line of Credit

You can apply for a line of credit through a bank or credit union, an online lender, a business loan broker, or through an online marketplace where you’ll be able to shop among various lenders. Lenders will most likely evaluate: 

  • Time in business: 2 years or more is ideal but some are more flexible.
  • Personal credit scores and/or business credit scores: Lender qualifications vary but many require personal credit scores of 600-650, and banks often want even higher scores. 
  • Revenues: These will be verified via bank statements, financial statements, and/or tax returns.

If you do not have a business bank account, you will find it more difficult to qualify. In addition, some lenders will not lend to sole proprietors, so incorporating your business as an LLC, S Corp, or C Corp can be helpful. 

When a Business Line of Credit is a Good Idea

Similar to most business 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. 

Pro tip: While a business line of credit can be useful to most business owners, if you are looking for a lump sum of money to fund a one-time project or a long-term project, a small business loan (particularly a term loan) might be a better fit for you than a business line of credit.

Best Business Lines of Credit

You have a wealth of options available to you when it comes to a line of credit. Here are some we recommend.

Fundbox

Fundbox is a popular online lender. Your business must be based in the US and should have been in business for at least 6 months with annual revenues of at least $100,000, a personal FICO score of 600+, and a business checking account. If you qualify, you’ll make weekly payments for 12 or 24 weeks. Interest rates vary.

Ondeck

Ondeck offers fast approval online for lines of credit between $6,000 and $100,000. Qualifying borrowers make weekly payments for 12 months. Interest rates vary. There is no prepayment penalty.

Newtek

Newtek offers, in addition to lines of credit, equipment loans, term loans, and invoice factoring. To qualify, you’ll need a 625+ credit score, be in business 2+ years, and have $250k+ in revenue.

Business Line of Credit vs. Business Credit Card

So I told you earlier that a business credit is a line of credit. So why choose one over the other?

If you need cash, such as to pay contractors for remodeling work, a line of credit may be a better option. Also if you need tens or hundreds of thousands of dollars, a credit card won’t let you charge that much.

On the other hand, if you need to be able to purchase supplies or equipment at stores and online, a business credit card may be a better fit. Know that credit cards tend to have high interest rates, though some have great 0% interest welcome rates. You’ll want to pay off your balance in full to avoid high charges.

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 a 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 more risk. Personal and business 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.

This article was originally written on August 8, 2018 and updated on December 3, 2021.

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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.