Many small business owners often find themselves short on cash at the most inopportune times. These businesses might have trouble with small business loans when they need them but it may be too late. A business line of credit is capital that small businesses secure when they can and use when they need to avoid cash flow issues. In this video, you’ll discover how a line of credit works and see if it's right for you; how to apply and secure a line of credit for your business; and stay until the end for some valuable tips to increase your chances of getting your own line of credit for your business.
What is a Line of Credit?
A line of credit is a short-term, revolving credit (open-ended) account you borrow up to a set amount from $10,000 to $1,000,000, depending on the type of the account and institution. Similar to credit cards, the LOC can be accessed to pay for equipment, repaid, and accessed again as long as the credit limit isn’t reached. Depending on the institution and credit agreement, there may be maintenance fees if credit utilization is not met. Terms for the LOC last for 1 to 5 years between renewals where the business is reassessed.
Secured vs unsecured
LOCs, come in two flavors: unsecured and secured. Unsecured lines are so because they do not require any collateral to use for your business. Unsecured LOCs generally have smaller amounts that small businesses can borrow and lower interest rates but tend to be variable based on prime rates and these amounts can range from 10,000 to 100,000 as an unsecured line. A Secured Line of credit requires collateral due to the larger loan amounts of 100,000 up to 1,000,000 depending on the bank institution. Secured lines of credit generally have slightly higher interest rates because of the credit level but are fixed due to the benefit of having collateral.
Benefits and Drawbacks
The biggest benefits to the line of credit are immediate access to working capital to meet a broad range of business needs. Another benefit is, much like a credit card, the business only pays the interest on the amount utilized in the account. It may seem like lines of credit may be a great source of funding but it’s not without its drawbacks. As we have seen, the amount you approved will depend on the strength of the company and the collateral you have for secured lines of credit.
How to get one?
Finding a banking institution
If you are looking to get a LOC for your small business then your first step is to find a banking institution. Ideally, the lender of your line of credit is from a bank you already have a relationship with. If your bank does not have what you need then online lenders like blue vine may have LOC that can meet your business requirements but are likely to charge higher interest rates for the easier approval process. You may find local community banks or credit unions to have better rates or have more flexible terms than the larger national bank.
Application
When applying for your small business line of credit there are some terms you should be aware of during this process. The first thing you should be aware of is that most institutions will require the business to be in existence for 2 years. The next thing you will need to understand is how credit affects your business application and that depending on the institution, credit ranges can be as low as 500 to 600, but you will need to check with the bank to compare plans.
Required documents
So now that you know where to look, and how to evaluate that application, let's take a look at the documents you are going to need to complete that application. Like a traditional loan, your institution may require financial documents like income statements for proof of revenue. If you already have a relationship with the lender or bank with them, bank statements can be used to verify income and the financial health of the business. Your lender will also want to know how much debt your business has, so a balance sheet or schedule of debts will be needed. Finally, the lender may require personal and/or business tax returns for at least 2 years to confirm revenue and expenses.
Line of Credit Tips
Tip 1: Know your need
As I mentioned earlier, LOCs have different credit limits whether they are secured or unsecured. You will need to understand your needs when it comes to your business. Why? If your need is far more than you realize, then you may need additional collateral to meet it. However, you may think you need more for your business but without a firm grasp of your finances, you will not be able to protect or increase your cash flow.
Tip 2: Understand your credit
Before you are able to apply for a line of credit, you need to know your credit. Many times, small business owners who are looking to get any kind of funding including a LOC, don’t know their credit score or have a poor credit score and are NOT taking steps to rectify it. Any applicant will need decent credit to apply for a line of credit and each institution will have different thresholds. If you need help building your business credit, check out our video here.
Tip 3: Plan Ahead
What you need to understand about this process is that it takes time. From building up your credit to the actual application, it could take a day for online lenders to a few months for traditional lenders, to make a decision and get approval. You shouldn’t wait until you are desperate for money, but be actively monitoring your business finances for signs that getting a LOC might be a reasonable course of action.
Conclusion:
Lines of credit are viable solutions to a short-term cash crunch and more flexible than traditional small business loans for inventory, supplies, or equipment. You can pay off what you need to and still have access to funding for years. You should create a relationship with your banking institution early on to make applying for the LOC easier when you need it. You should also understand your business financing needs, credit, and timeline when it comes to funding your business or before your cash flow becomes an issue.
Funded in part through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, conclusions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.
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