As a small business owner or entrepreneur, you’re probably going to face cash flow problems along the line. You may need some funds to buy some equipment, cover an unexpected cost or mitigate seasonal fluctuations in operational cost and profit. Raising these funds may be a serious problem to an entrepreneur. While it’s becoming more and more difficult to borrow from big banks, line of credit turns to be a better alternative.
What is a Business Lin of Credit?
This can simply be regarded as a form of a credit card without a card. This allows you to get money against a predetermined limit, according to your need without collecting the full amount of loan at once. Small business line of credit is a type of revolving loan that allow borrowers access to a fixed amount of funds, which they can use to supplement their daily expenses. This type of credit is mainly for short term financial needs. The main benefit of small business line of credit is that it provides ready cash flow to companies that need to purchase large quantity of inventory up front or have variable operating expenses and it only allow borrowers to pay interest on the funds they actually withdraw and not on the total amount of credit.
It’s revolving in the sense that, as you pay down the loan on your credit line you increase your borrowing power. That is to say, your lenders increase the amount of money you can borrow as you keep the good faith of paying your loan in time. To make things clear and better understand, let’s look at this scenario:
Like a loan, a bank gives you access to a certain amount of money (say $50,000) you can use. You are not requested to pay interest on this $50,000 if you don’t use it. If you used $10,000 for example to increase your inventory, you are then requested to pay interest on the $10,000 plus the $10,000. Until you completely pay the $10,000, you will still have $40,000 to use. Once you completely pay down the $10,000, you will automatically have another $50,000 to use. You don’t need to apply again for loan. Depending on your credit score, some lenders will instead add the $10,000 on the $50,000 thereby increasing your credit limit to $60,000.
Why do you need a Line of Credit?
Imagine you are a business owner who finds himself in a situation where your business is trying to pick up, orders are flowing in but your clients a keeping (owing) a greater portion of your money. As a consequence you won’t be able to meet the demand from new clients and your vendors and employees don’t care whether someone owes you money, they need theirs now. How can you solve such a problem?
Here is where you know you really need a line of credit. As a matter of fact, a line of credit can act as a business reserve where you pick up money only when you need it most to solve immediate problems. And because you do not interest on money you have not used, it’s makes it a very important component for every business owner to have.
Below are some reasons why you would need a line of credit:
- A line of credit can help you when you need to purchase more inventories for greater revenues. The gap of time between purchasing inventory and being repaid can be a hardship for some businesses.
- To entrepreneurs running seasonal business, it can tide you over in the lean months.
- It can help business owner who may want to expand their facilities towards greater profits.
- If you usually find yourself running into monthly cash shortages or debts that are later remedied when your debtors or invoices are paid, then a line of credit maybe for you.
In whatever case, a business line of credit is a very useful and strategic tool. Therefore it’s very important for every business owner to plan ahead to have a business credit available when you need it, which can also save a great deal of stress in times when you could find yourself in a financial crunch. An uninterrupted supply of funds can help your business to run smoothly without the damage that unplanned or unexpected cash flow problems can cause. Though your cash flow may be smooth today, but that is not a guarantee for the future. It may be really disappointing to find yourself unable to pay employees or vendors a few months down the line when there’s not enough saved in the bank.
Accessing a Business Line of Credit
Most major lenders that serve small businesses offer business lines of credit with a credit limits up to $100,000. To access a business line of credit, you may be required to fulfil or meet some prequalifying conditions. Most business line of credit lenders based their lending decision on the following factors:
- Credit Score: They usually required a credit score of 600 or more in order to consider an applicant
- Duration in Business: A minimum duration of one year is the base for most lenders
- Business Revenue: Most lenders required minimum revenue of $2,500 for at least the three recent months
- Positive cash flow: It’s the desire for lenders to know whether you have the ability to make regular payments against your loan.
- Short-term Asset: Most lenders will required you to back up your loan with a short term asset like assignable contract or accounts receivable
- Have good credit: In order to minimize risk, lenders verify you credit history. Loans are easily awarded against good credit history.
- Hard Assets: Common with large amounts. Lenders will require borrowers who wish to loan very large amounts to back up their loan with collateral usually a machinery, real estate, or equipment.
As a rule of thumb, businesses that better meet these requirements will qualifier for lower interest rates, larger credit limits, and more generous repayment schedules.
Don’t fall into the temptation of trying to get a business line of credit for a larger amount than you need. While you won’t pay interest on the amount you don’t used, it’s going to lower your credit score. The best is to start small, get just the amount you need and repay promptly. Bear in mind that you can always increase your limit later.
Types of Business Lines of Credit
Business line of credit can be divided into two main types. Namely, secured and unsecured business line of credit.
Secured Business Line of Credit: With this type of business line of credit, borrowers must show prove of their ability to repay the loan this is usually by means of a collateral which may include some short-term assets, like accounts receivable or inventory, real estate, equipment, or machinery. In the unforeseen event whereby the business owner is unable to repay the loan, the lender may take ownership of those assets or sale them to recover the balance. This type of line of credit is usually approved for a larger amount and with a lower interest rate because of the collateral.
Unsecured Business Line of Credit: This business line of credit type involves lenders issuing money to borrowers without collateral. The lending decision is mostly based on the borrower’s credit rating and business track record. There are usually higher interest rates (20% to 30%) and lower credit (small amount) due to the fact that lenders are assuming more risk by not seeking collateral. It’s also more difficult to secured unsecured business lines of credit compared to the secured type.
Microloans, the Alternative to Business Lines of Credit
These lenders are usually less difficult rout to get small business loan. Many of them focus on minority or traditionally disadvantaged small businesses and small businesses in communities that are struggling economically.
Generally, they provide better loan terms, making it possible for you to grow your business and establish better credit. This in other terms can help you qualify for other types of financing.
If you’re unable to qualify for a business line of credit you can secure small amounts of money for your business from a microloan lender. Microloans are usually given in amounts less than $50,000, and they’re also easier to secure compared to traditional business lines of credit from commercial banks. You may also be required to back up your microloan with some collateral as security.
Micro-lenders look for the following when deciding loan for small business applicants:
- If the business owner current is on all business and personal bills
- If the business have enough cash flow to be able to make repayment
- If the business owner’s financial history is free of bankruptcies or late mortgage payments in the past year.
Rightly speaking, cash flow problems don’t have to put you out of business. With options like business microloans and business lines of credit, your business should be able to withstand any financial storm. Below are some examples of microloans you may want to choose from.
If you can’t get a traditional loan from an online lender, you can try Invoice financing. Invoice financing allows you to obtain money for invoices before the client pays (a percentage of the bill is usually given to the lender).
This is a system of raising funds for small business from online companies and instead of repaying your donor; you offer them gifts (why this system is also known as reward crowdfunding). It is now very popular among small business. Examples of good sites for crowdfunding include Grameen America, Indiegogo and Kickstarter.
There are new avenues springing up for equity crowdfunding. This allows you to tap a public pool of investors who agree to finance your small business in exchange for share or equity ownership in your business. This became an even broader option of recent with new securities regulations that allow small-business owners to reach out also to non- accredited investors.
This system is good for the entrepreneur who has a product and wants to test the market and validate the opportunity.
Business cash advances
Also called a merchant cash advance, these loans provide you with a lump sum of capital. You repay by giving a portion of your daily credit card sales. The approval process is easier than other loans and you don’t need stellar credit. However, fees are some, if not the highest on the market.
Peer-to-peer (P2P) Online Business lending: This is a means of getting business loans online mostly for small business online. Here people go online to lend and borrow money directly to each other. You get easy online business loans compared to traditional banks once you fulfilled all the requirements. The advantage here is that you get easy online business loans on the other hand; their interest rates are one of the highest in the industry.
Some lend money against your credit card receivables based on your credit scores. They offer business line of credit to you with minimal paperwork, and use technology and proprietary algorithms to make business lending decisions.
There are a number of site you can visit for a P2P loan. Example include Prosper.com and Lendingclub.com.
Business Loans Online Specifically for online businesses
For already existing online businesses that are seeking money to grow, e-commerce business offers a financing option for its business customers. They instead make business lending decisions using a proprietary algorithm and technology based on the historical value of your sales and ecommerce transactions. Therefore if you have good revenue stream, you are awarded a loan against future revenue that comes in on the ecommerce platform. As ecommerce transactions clears, they deduct a portion for the loan payment. This is a low-risk loan for them because you have a track record and they believe you won't disappear as a seller. Examples include PayPal Working Capital.
It is essential to find the online business loan that fit your business plan and pays to be as prepared as you possibly can. Verify all the possible loan options at your disposal and ask all your questions to the lending officer. The more research you do, the more caution you take and the better off you’ll be in the long run.
A line of credit may be an affordable solution to short-term working capital needs but it requires you to plan your application in advance to get the best rates and terms. There are like any financial product, neither inherently bad nor good, but rely only on how you use them. Excessive borrowing against a line of credit can get you into financial trouble. Your best line of credit option is through a traditional bank lender, but the problem is their qualifications which are very hard to meet. For the long-term capital investments or purchase of hard assets, you’d likely be better off with a business term loan.
True to the case of any loan, borrowers should pay careful attention to the terms (fees, interest, and repayment schedule), shop around and not be afraid to ask all their questions before signing.