When researching funding options for your small business, you may have read about business lines of credit and wondered how they differed from typical business loans. Here’s the deal.
1. What is a small business line of credit?
A business line of credit is just as it sounds: It is a line of credit that the business owner can draw from as needed. The lender will set a maximum amount that the business owner can draw, but otherwise you can pull funds as you need them. It’s a little bit like a credit card on a much larger scale; you can’t exceed your credit limit but otherwise you’re good to go. And of course, you’ll have to pay interest on your balance.
2. How does a small business line of credit work?
A business line of credit generally does not charge interest on the unused credit amount until the business owner uses those funds. Some business owners use these funds to run their business operations or as needed when a cash flow emergency arises. Business lines of credit are intended to be used for temporary, short-term business funding needs. A payroll shortage, buying extra seasonal inventory, vendor invoices, and purchasing new business or supplies are all reasons why a business owner might tap into their business line of credit.
As with any business financing decision, there are pros and cons to a business line of credit. The pros include 1) immediate access to working capital 2) only paying interest when funds are drawn and 3) access to immediate funds to help cover a broad variety of business needs. The cons include 1) potentially high interest rates 2) occasional need for up-front collateral and 3) business owners may be asked to update records and lender documents regarding the line of credit.
As a savvy business owner, it’s important to weigh the pros and cons to decide if a business line of credit is a viable funding option for your small business. If you do decide to pursue a business line of credit, you should make sure that the lender adheres to the tenets of the The Small Business Borrower’s Bill of Rights.
For other lending and financing options available to your small business, visit our resource Funding Options to Start and Grow Your Small Business.
3. How do you get a small business line of credit?
A business line of credit is a kind of loan, so the process for securing a business line of credit is similar to that of applying for any other business loan. You’ll need to prepare documents and an application; you’ll probably need to provide a business plan to reassure the bank that you have a strategy for coming up with the cash you’ll need to pay them. For more on general small business loan prep, including the documents and materials you’ll need, visit our resource Get Your First Small Business Loan.
The strength of your application will determine how large a line of credit you can get and what your interest rate will be. As with any major financial decision, you should shop around and see what kind of deal you can get at various banks and lending institutions. Don’t forget to check with your local banks; they may be more willing to work with small businesses than national or international institutions.
Draw When You Need It
A business line of credit is a particularly flexible tool to keep in your back pocket. You don’t necessarily want to depend on it as a regular source of cash given the interest you’ll have to pay, but it can be a lifesaver if you have a cash shortage. In some cases, a business line of credit may be a helpful financing tool, but you should meet with your financial advisor to determine whether that’s the best option for your business needs.