Why Every Business Owner Should Consider a Line of Credit

September 23, 2022

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A business line of credit is a business financing option that allows business owners to access a ready line of credit. Often referred to as a BLOC, this method of business financing is considered one of the essential business funding resources for entrepreneurs.

Over 80% of small businesses will require access to capital in their first five years of operations according to the 2021 Federal Reserve Bank SMALL BUSINESS CREDIT SURVEY.

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How Does a Line of Credit Work?

Unlike a conventional bank loan, a business line of credit is “ready cash”, to be used when needed in fractional amounts up to the credit limit. A borrower who is granted a business credit line chooses when and how much to draw. What’s more, the business owner begins repaying and accruing interest after they draw on the credit line. That’s why this type of financing is referred to informally as “ready cash.”

With a traditional bank loan, or a term loan a borrower is given a lump sum payment and begins repaying the loan amount (and pay interest) once the funds are disbursed. Traditional loans may also involve paying an origination fee. This type of loan is more suitable for businesses that have an immediate and specific purpose for the capital.

To make the point further, a BLOC is also compared to a business credit card. While this comparison is valid, there are some big differences in repayment terms, interest rates, annual fees and credit limits. Anyone who has taken a cash advance on a business credit card understands that it is often associated with very high interest rates. Credit cards and merchant cash advances will almost always carry higher interest rates than other types of financing.

Why Business Owners Should Start to Establish A Business Line of Credit as Soon as Possible

Building a credit line with a financial institution is as important as business insurance or having the right equipment. The statistics showing unexpected need for additional business capital is overwhelming. The bottom line? It is very likely your small business will require additional funds at some point.

Many advisors urge business client to establish business credit immediately, even before there is a need. The reason for this is simple. It is more likely that a financial institution will provide financing when your business is strong and solvent than when you are experiencing financial stress.

It may be difficult to grasp the notion of securing financing before the need arises, but it takes time to build business credit so the sooner you begin the process, the better-off you will be when the need arises.

Small business owners can start by opening a business bank account at a regional bank or credit union, or by establishing a relationship with an online lender. Once you have established the relationship with your financing company of choice, you can begin by applying for a small line of credit, pay it back promptly and start to build your business credit.

What Are the Requirements for a Business Line of Credit?

The application process for a business line of credit is fairly simple and in many cases is similar to that of a business credit card. With online lenders the average time to apply for a credit line can be as little as 5 minutes and a decision is usually given within 24 hours.

Like most types of financing, a credit line will depend on the applicant’s creditworthiness. If you are a new business, it may depend on the strength of your credit score and you will likely need to have your credit report pulled by the financial institution.

Qualifying for a small line of credit (up to $20,000) has become a very simple process and may only require the lender to review your credit profile. For larger amounts, the financial institution may ask you to submit financial statements, tax returns and bank statements for several years of operations. The size of the business line of credit may also be dependent on your company’s annual revenue which is an indication of how much free cash flow you will have to repay the funds.

Can You Get a BLOC if You Have Bad Credit?

The short answer is yes! However there is a difference between bad credit and weak credit. The longer explanation will be determined by your financial institution. For example, a traditional bank will often have stricter qualification standards than many online financing companies. Generally speaking, banks may require a personal credit score of 680 or higher. While this is not set-in-stone, it is a guideline.

The new breed of financial technology companies called FinTech companies us more progressive (less stringent) criteria to evaluate creditworthiness. Similarly, having a relationship with an online funding company, a credit union or smaller financial institution may increase your chances of getting a business line of credit.

Using a BLOC wisely and paying it off in a timely manner is also a great way to build a stronger credit history.

What is the Difference Between a Secured and Unsecured Business Line of Credit?

A secured business line of credit means that you agree to “secure” the financing with assets (pledge collateral) or by making a personal guarantee to repay the funding. If you are willing to back your line of credit with real estate, equipment or other assets, it will greatly increase the likelihood of getting the financing you require. It is common for many financial institutions to require a secured line of credit for startups.

A secured line of credit may also be an option if it offers a lower interest rate.

With an unsecured line of credit, the financial institution relies on the business to make monthly payments until the funds are repaid. Generally speaking, an unsecured line of credit may carry higher interest rates than a secured line of credit.

What Can I Use A Business Line of Credit For?

A business line of credit can be used for almost any purpose such as for working capital. While your financial institution may have some restrictions, this type of business financing is almost always for general purposes.

However, cases where a BLOC can be very useful are when your company experiences unforeseen or unplanned expenses or business needs. These could include business expenses such as repairs or for when cashflow unexpectedly falls. Therefore, it is advisable to treat a small business line of credit like an emergency fund.

Alternatively, your line of credit can be used to take advantage of purchasing opportunities that allow your company to take advantage of quantity discounts or cash discounts.

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