Business owners looking for debt financing typically have three main options: a business loan, a business line of credit, or a business credit card. It’s important to consider the pros and cons of any funding source before determining which makes the most sense for your business.
A business line of credit works similarly to a business credit card. Unlike a loan, you won’t receive the entire amount of cash you request upfront. Instead, if you’re approved, you’ll be granted a credit limit and can borrow any amount up to that limit. You’ll be charged interest only on the amount you use, not the full amount you can access.
Businesses are granted different types of credit access when approved for a line. Financing terms will vary depending on the lender and business, but a good place to start is a breakdown between revolving credit and non-revolving lines of credit.
With a revolving line of credit, you are approved for an amount of credit and can borrow up to that amount. You only need to repay the amount you borrow. As you pay off the outstanding balance, it will ‘re-fill’ the credit line. For example, let’s say you’re approved for a $200,000 revolving line of credit and you draw $150,000. You still have $50,000 available to borrow before the credit limit ceiling is reached. But if you repay the $150,000, you’ll have access to the full $200,000 again. The credit line revolves over and over. Revolving credit is ideal for many businesses because it helps smooth cash flow during day-to-day operations.
If revolving credit functions like a credit card, then a non-revolving line of credit is like a prepaid card. A borrower granted a non-revolving line of credit will receive a credit limit and can borrow any amount up to that limit. But unlike a revolving credit line, a non-revolving credit line does not refill after repayment — the account will be closed once the credit limit is reached. So, if we take the example above, you’ve used $150,000 from your $200,000 line of credit. You have $50,000 left to borrow. With a non-revolving line of credit, even if you repay the $150,000 immediately, you will still only have access to $50,000 in funds.
A revolving line of credit is the preferred type for most business owners since it can act as an endless source of cash. For specific one-off expenses, a business may prefer the one-and-done nature of a non-revolving credit line. But these aren’t the only two distinctions between the various business lines of credit. Here are two more factors to consider when searching for a suitable lender.
A secured business line of credit often comes with more favorable terms and higher credit limits since assets from the borrower are used as collateral. With a secured line of credit, business owners offer up receivables, equipment, property, or other assets to back up the credit line and lower the default risk for the lender. Should you borrow and not repay, the bank would have a claim on the assets used to secure the credit line.
An unsecured business line of credit requires no collateral in exchange for the access to funds. A borrower’s creditworthiness and business history will be considered when assigning terms, but the lender will be on the hook should the business default and not repay the borrowed capital. Since this type of credit line poses a greater risk for the lender, the terms tend to be less favorable for the borrower and the credit limits are often more conservative.
Funding sources like business lines of credit have their benefits and drawbacks. Here are a few to consider on both sides.
Balances Cash Flow - One of the biggest benefits of a business line of credit is its ability to balance company cash flow. Business expenses like inventory, payroll, and taxes may not line up perfectly with customer invoice payments. A credit line creates a cash flow extension so businesses can run smoothly.
Scalability - By only paying interest on the amount of money spent, business owners can scale their companies more efficiently using lines of credit. For example, if a business owner is approved for a $100,000 line of credit, but only needs $50,000 today, they will only pay for that $50,000. As the business grows, they can tap into additional funds within the approved limit.
On-demand Funding - Occasionally, a business owner will want to take advantage of a new opportunity immediately. If they already have access to funds through an open line of credit, they can avoid applying for a business loan and waiting for it to be processed.
Fees - Lines of credit may carry certain fees not associated with term loans, including charges for accessing the line of credit or initial funding expenses. Some hide additional fees in their contracts. This certainly isn’t the case with all lenders, so be sure to consider the contract terms carefully before deciding on a funding source.
Application Requirements - Not every business owner who applies for a line of credit will be granted one, especially if collateral isn’t offered in return. To qualify for a business line of credit, you’ll likely need to prepare not just your business credit history but also cash flow statements, tax returns, bank information, and more.
Borrowing Limits - A one-time loan may grant access to a higher sum of money. If your business has a significant but specific expense coming on the horizon, a term loan is probably a better option.
When applying for a business line of credit, it’s best to have a strategy for the funds, along with minimal debt and good credit scores. Use the following tips to utilize credit lines efficiently while improving your company’s standing with prospective lenders.
Business lines of credit don’t have specific use requirements like loans, but it’s still a good idea to have a plan for the capital. The lender will be much more likely to grant a higher limit if you can communicate a straightforward process for using the funds.
Despite the temptation, a line of credit shouldn’t be used as a piggy bank for your business. Instead, withdraw only the amount you need to service your company and pay it back as soon as possible. Like credit cards, overusing business lines of credit can create debt problems.
The highest credit limits and lowest interest rates go to those who offer collateral to the lender, which makes funding your business less risky. If you have a plan for the cash and can manage repayment, using collateral for a business line of credit can significantly decrease your borrowing costs.
Lenders want to see an organized company with plenty of business history. Therefore, have any potentially pertinent documents from the last few years ready for a lender to view. This may include documents like tax returns, revenue statements, debt loads, cash flow statements, and balance sheets.
Business owners looking for simple and quick access to capital should consider Aion for their borrowing needs. Aion offers accessible applications for business lines of credit with complete transparency on rates and terms. Plus, an all-in-one finance platform makes it easy to access all of your business finance data and present it to be qualified for line of credit. Apply today or use the chat bubble in the bottom right corner to connect with a lending expert.