Should You Consider a Business Line of Credit?
Credit cards are one of the most popular forms of business credit. But they can't always address your firm's needs. When times are tough, a business line of credit can help you to make payroll, pay rent and utility bills, and maintain inventory — with typically lower interest rates than credit cards. Consider these benefits of having a business line of credit for your firm.
The Pros of a Business Line of Credit
1. You can improve cash flow during slow seasons.
For many types of businesses, a line of credit is the ideal tool for balancing cash flow. Here's an example: A retail store in a coastal resort town brings in most of its revenue from late spring to mid-fall. The business is often short on cash during the winter and has trouble making payroll, even for its reduced staff. Because the owner can't use a credit card to pay her employees, she takes out a business line of credit to boost cashflow and ensure that the store meets its overhead expenses.
3. You won't miss out on sudden opportunities.
If you have a limited window of time to take advantage of a deal on inventory or supplies, a credit card might not be enough. Or maybe there's a new space you can get at a bargain price, but it needs some TLC and you have to build it out. Once you receive a business line of credit, you won't miss out on an excellent opportunity to save money or expand your operations.
4. You'll be building your firm's credit score.
Down the road, you'll need a solid credit history to get the best terms and interest rates on a loan. So if you'd like to boost your business's credit score, receiving a business line of credit can be a fantastic way to do it.
5. You'll enjoy greater buying power.
Credit cards are fine for regular supplies, travel, and other regular expenses. But a business line of credit's lower interest rates and higher credit limit mean it's less expensive to make larger purchases like a delivery vehicle, special manufacturing equipment, or the construction of a trade-show booth, just to name a few.
The Cons of a Business Line of Credit:
A business line of credit comes with some potential downsides.
1. You may pay extra fees.
Don't be lured in by a low interest rate only to be slapped with numerous fees upon signing the agreement. Research and compare online lenders' annual fees and other costs before committing to any loan.
2. You may pay a variable interest rate.
Business lines of credit are often based on the prime rate — the rate at which bank lend to their best customers, plus a percentage. So someone who opened a business line of credit a few years ago, when interest rates were low, may now be paying significantly more for that money today. Ask the lender about rate caps and other factors that can inform rate hikes.
3. You'll need to provide full documentation.
A business line-of-credit lender will ask for:
Annual financial statements, including tax returns and profit and loss statements
Checking and savings account statements
Your business plan or other strategic documents
Often, you'll need two years of business history to qualify for a line of credit. If you don't think you can provide this depth of information, you could consider other types of financing, like a small-business loan or a cash advance, with shorter and simpler application processes.
4. You may be liable to pay back the loan, even if your business dissolves.
In many cases of less established businesses, getting a business line of credit requires that the business be personally responsible for the loan, even if the business fails. This can be the case even in with an S-corporation, which otherwise grants separation from personal liability. Be sure to read your agreement carefully before signing.
5. You may be tempted to abuse the credit line.
A business line of credit should only serve as safety net for cash-flow shortages and planned large expenses. It's often tempting to use it casually, like a credit card. So if your business already has significant debt, or you're unsure about your ability to repay an LOC, this might not be the right time for you to take on a line of credit.
Another option: The secured business line of credit
Despite a more encouraging economic forecast, a July survey by the Federal Reserve reports that businesses are still having trouble getting credit. One way to get around this potential limitation is to apply for a secured business line of credit (LOC). When you take out a secured LOC, you're offering collateral — equipment, real estate, or other substantial holdings, as security for the lender.
A secured loan offers significant benefits.
Potentially lower interest rates. When you offer real estate or other assets as collateral on a loan, the lender's reduced risk may get you a lower interest rate — though it's not a slam dunk.
Some allowance for low credit scores. You don't want to lose your pledged asset(s), so you're more likely to do your best and repay the loan.
You may get a longer payback period. Because business property is often used to back secured loans, lenders can rely on rising property prices to increase the collateral's value over time. That's a serious plus if you default.
Keep in mind: If you default on your business loan, you'll likely lose the asset tied to your loan. When possible, use only property that won't affect your business or your home — like an investment property or a second home.
Shop for capital from a position of strength
As with any decision to take on debt, consider if a business line of credit is suitable for your company right now. Apply for a business line of credit when you don't require it. If you wait until you have an urgent need, you'll be in a poor bargaining position.
A business line of credit can be a boon to your business during temporary slow periods of low cash flow — provided you shop for the best terms possible and use the funds wisely if you're approved.
Since 2008, Fora Financial has distributed $4 billion to 55,000 businesses. Click here or call (877) 419-3568 for more information on how Fora Financial's working capital solutions can help your business thrive.
