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
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.
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.