Every small business owner encounters situations where they need quick access to extra capital. Traditionally, one of the most popular options for handling day-to-day cash flow needs has been a business line of credit.
A business line of credit (or “LOC”) is a revolving loan that gives business owners access to a fixed amount of money, which they can use day-to-day according to their need for cash.
LOCs are specifically designed to help businesses finance short-term working capital needs, such as:
A term loan involves a fixed amount of funds loaned out and repaid over a fixed time period. The business owner takes the proceeds from a term loan in one lump sum. A term loan is repaid in a prearranged schedule of payments that stay constant until the loan has been repaid. The funds from a term loan typically go to purchase a specific asset, like a building, a vehicle, or other equipment that is valuable to the business.
A business line of credit is more flexible. With a LOC, businesses are given a credit limit they can borrow against whenever they need it, and they’re free to spend the funds on the costs of their choosing. Businesses then make regular payments that vary according to the current balance of the credit line, like a personal credit card.
While term loans work well for paying for long-term assets that will be used over many years, LOCs are best for short-term operating purposes and for more immediate revenue-generating activities because the business owner can access funds as he or she needs them.
When you open a line of credit, you’ll receive access to a stated amount of funds to use as needed. You then receive a monthly invoice reflecting the amount of credit you’ve used, along with any interest charges.
Your payment is based on the actual interest accrued on these funds while you use them. Once the funds are repaid, that amount is available when you need it. You’re only charged interest on the amount of the loan you actually use.
LOC rates and limits are set by lenders and based on your risk grade, your collateral, and any servicing requirements. Your risk grade is judged on factors like the financial success of your business, the state of your business sector in general, your business and personal credit scores, and whether or not you have collateral.
Most lenders will charge an annual fee for the LOC, in addition to interest charges. If you’re going to need a significant number of loan advances and repayments, transaction fees might apply.
Smaller LOCs (under $100,000) can operate as credit card account, with advances made by using a credit card or writing checks issued for the account. Accessing the funds can also be deposited directly in the borrower’s account via an ACH deposit.
If your business regularly requires funds to cover short-term cash flow issues, manage your business’ day-to-day needs, or take advantage of immediate business opportunities, then applying for a LOC makes sense.
Here are a few examples of situations in which it’s smart to get a LOC:
Example 1: A seasonal business that generates most of its sales in the summer could use a LOC in the off-seasons to help cover overhead or meet payroll. The LOC would allow them to maintain normal business activities even as their income fluctuates.
Example 2: A business could use a LOC to finance a marketing campaign, which would attract new customers and expand sales. The new debt will be paid off quickly because the campaign will generate additional revenue and grow the business faster.
Example 3: If your business needs to cover expenses while waiting for clients to make payments on sales you’ve made with terms, then a LOC could be useful for cash management.
A business line of credit can help your small business in a time of need, but there are some factors to consider that can potentially negatively impact your business.
Advantages:
A small business line of credit can offer near-immediate relief of a cash flow for your small business, solving for a variety of needs, including covering operating expenses through a slow period, helping your business to scale in a time of growth, or investing in new supplies or equipment. The rates for borrowing a small business line of credit may be lower than charging expenses to a credit card, and the repayment terms can be flexible, allowing your small business to access the small business line of credit funds as you need them.
Disadvantages:
Like with any financing, a small business line of credit can post challenges for your business and credit Defaulting on your small business line of credit can negatively impact your business and even personal credit, and make it harder for you to get approved for loans in the future.
If you have a new business without an established business credit profile or have a low personal credit score, traditional lenders will typically be reluctant to offer you a line of credit.
Most lenders prefer to offer a LOC to established companies with a track record and revenues to support the more flexible financing provided by the business line of credit.
Most major banks that serve small businesses—which include commercial banks, community banks, credit unions, and online banks—offer unsecured business LOCs. The credit limits at some banks are $5,000 to $100,000, while other lenders will go as high as $500,000.
All lenders will usually only consider “established” businesses that are at least 2 years old and have a positive track record of growing revenues and profits.
For newer businesses (under 2 years old), some banks offer LOCs backed by the U.S. Small Business Administration (SBA). The SBA’s CAPLine program offers eligible businesses the option of four different types of LOCs to help finance their short-term capital needs.
Before opening a business LOC, make sure you understand your lender’s qualifications, loan conditions, interest rates, and fees.
Once you decide to apply, gathering all the necessary paperwork is 75% of the battle. Any lender will want to see your business documents, including financial statements, tax returns, your resume, and an explanation of your business history. The lender also will expect to see a three-year projection of business revenues and expenses, with an explanation of how and when the LOC would be used to support your cash flow. You might also be asked to provide detailed schedules of the company’s accounts receivable, inventory, and all liabilities.
Lenders look critically at LOC applications to determine whether the company needs funding to cover growth opportunities. Lenders do NOT want to:
In order to demonstrate that your business is qualified for funding, be prepared to show:
To Sum Up
Business lines of credit help small businesses grow revenues and expand profits. They offer financial flexibility to cover gaps in the normal business cash cycles. They can be used to harness the necessary resources to maintain activity year-round and can fund expenses to develop your vision, build your organization, and amplify success. So look ahead and apply before your next busy season – it’s best to have the cushion before you need it.
Many online lenders use technology to evaluate businesses differently from traditional lenders. For example, online lenders may access a business’ transactions and cash flow via their bank account’s website or examine other digital data points to analyze a business.
What is an Online Business Loan?
An online business loan is a source of funding that businesses can apply for and access via online lenders. Online business loans are useful options for small businesses in particular, because the application process is easier, and approval time can be shorter than traditional business loans.
This lender provides business owners with loans ranging from three to 24 months. These loans are often used for specific, shorter-term projects such as purchasing inventory, launching marketing campaigns, or general working capital. Some examples of shorter-term lenders are:
These lenders provide business owners with loans that range from 1 to 5 years with amounts up to $500,000. These loans are often used for longer-term projects such as major renovations or the opening new location. Some examples of these longer-term lenders are:
Online business loans present some benefits over traditional loans, including:
Best Uses for Online Business Loans
Online business loans can be used for a number of business needs, including:
Online Business vs. Traditional Business Loans
Online business loans are distinct from traditional loans in several ways, many of which are favorable for businesses, particularly small businesses, but there are some watch-outs.
Online Business Loans
Traditional Loans
Choosing the right loan for your business will depend on several variables, including:
Services like kerfunding.com can help you compare what business loans are available to meet your needs and qualifications.
Rates & Repayment
Online business loans tend to have a higher interest rate relative to traditional bank loans. However, they also have much higher approval rates and can provide funding far quicker than traditional lenders. The rates will vary by lender, term, and risk and are typically lower than other options such as merchant cash advances. Repayment methods also vary depending on the lender, so make sure to do your research and find the best fit for your business. Some lenders require a fixed amount daily or weekly, while others require a traditional monthly payment.
Qualifications and Requirements for Online Business Loans
These both vary from lender to lender, but here are some general guidelines:
The type of business loan that’s right for your business will take into consideration the above factors as well as what lenders will approve your application. Some of the best online business loan options are:
Application Process
A major benefit of online business funding is how easy it is to apply for a loan. Applications are usually just a single page and tend to be very straightforward. They can be completed online, over the phone, or via fax. However, there are certain things you’ll need for non-bank lenders, including:
Another advantage to working with online lenders is the quickness of their review process. The shorter-term lenders can often provide a decision in minutes or hours, while the longer-term lenders may have a decision within a few days. In a world where an application for financing in a traditional setting can take weeks or even months, the speed and simplicity offered by online business lenders are a major attraction for many business owners.
Set your business up for financial success.