Managing a small business’ cashflow is a full time job and there’s no shortage of people and companies trying to sell financial products and services. From invoice financing to business credit cards, there are a lot of ways to find financing (not all of them good).
What is a line of credit?
If you understand how a credit card works, then you understand what a line of credit is. A line of credit is a source of financing that can be tapped at any time by a borrower. Here are some attributes of this type of financing to help familiarize yourself with the idea of a line of credit:
- Credit limit: Lines of credit are extended from a lender (could be a bank, alternative financing source, or credit card company) to a borrower with a cap on how much a borrower can borrow.
- Revolving credit: A borrower doesn’t have to use the entire line and only pays interest on the outstanding balance. As a borrower pays back the line of credit, he reduces his outstanding credit and can now can theoretically borrow more as part of the line of credit.
- Security: Like other forms of financing, lines of credit may or may not be secured by a business’ property. Whether a lender requires a business to put up some collateral depends on the lender.
What’s a line of credit good for
Flexibility is the name of the game when it comes to using lines of credit to finance your business. They can provide the security of a rainy day fund — money you can tap into when things hit the fan. Business lines of credit are also good for very short term financing needs — like, if you needed to buy some extra inventory to prepare for the holiday season.
Lines of credit are good for relatively healthy businesses that need a short term infusion of funds to maintain cashflow. They’re expensive to maintain longterm if you keep an outstanding balance, so they’re really designed for defensive, short-term type spending. Lines of credit are not growth capital (money you want to invest in driving sales) and it’s not money that should be used to bail out a company.
How to qualify for a business line of credit
According to FitSmallBusiness, lenders generally look for five different things when a small business applies for a line of credit:
- Credit score (min. 600+)
- Time in business (min. 12+ months)
- Recent revenues (min. trailing 3+ months)
- Short-term assets (like accounts receivable or assignable contracts)
- Hard assets (like real estate, machinery, or equipment)
Pros of using a business line of credit
- Flexibility: Lines of credit are very flexible and that’s important. Unlike installment loans which are very structured and require payment from day 1 after the loan is issued, many businesses set up lines of credit before they need them. You don’t have to use the whole line.
- Pay for what you use: Unlike a regular installment loan you’d get from the bank, you don’t have to make monthly payments on a line of credit until you actually dip into the funds. Nor do you pay interest on the entire line — with a line of credit, you just pay for the credit you use.
Drawbacks of a line of credit
- Cost for added flexibility: There are few free rides in life and the added flexibility an SMB owner would get with a line of credit comes at a cost. Business lines of credit can run from 5.25% to 80% APRs.
- Smaller borrowing limits: Compared to installment loans, you may find that business lines of credit generally offer smaller amounts of financing. While these types of loans are really flexible, they’re not great for growth capital or large expenses.
- Hard to get: Listen, qualifying for any loan comes down to your credit history and business credit score. These are generally risky loans (the unsecured version, anyway) and they may be hard to qualify for.
Online resources for business lines of credit
As lending has moved online, there are a growing number of providers who offer business lines of credit online or through a mobile interface.
- BlueVine (up to $150,000 LoC)
- Fundbox (claims it doesn’t require personal credit checks)
- StreetShares (designed for veteran-owned businesses)
- Kabbage (answers within 10 minutes)
- OnDeck (rates as low as 13.99%)