Every small business owner is keenly aware of the major expenses associated with starting a company and keeping it in operation. Whether it’s machinery for a construction company, ovens for a restaurant, inventory for a retail store, or vehicles for a transportation company, these purchases often require substantial financing.
In these scenarios, heavyweight loans such as equipment financing or business term loans can provide the money to make the purchases possible. Both of these loan options have maximum amounts in the millions of dollars, so the sky’s the limit.
On the other hand, scores of smaller purchases are just as important to your business’s ability to keep chugging along. These expenses may ebb and flow throughout the year, making it difficult to maintain constant cash flow. For recurring and one-time expenses such as these, a business line of credit can be an enticing option.
“Entrepreneurs frequently encounter difficulties managing their cash flow as a result of seasonal credit demands and time gaps between capital needs and revenue realization,” explains The Balance Small Business. “This is especially true of business startups during their early stages of development when they have not diversified enough to generate a constant positive cash flow. Once the inventory has been purchased, it is necessary to ride out the cycle until accounts receivable have been collected. Without sufficient working capital, a serious cash flow problem could develop.”
In the small business world, it’s always possible to make money and still run out of cash. A line of credit keeps the pump primed so you won’t be as susceptible to seasonal ebbs and flows and other factors out of your control. The easy access to capital allows you to buy the necessary inventory, equipment, or whatever else so you can set yourself up for forthcoming sales.
“If your business has a low season and a high season, you may consider spending on credit during the low season to push through to the high season,” says USA Today. “If it takes some time to collect payments from customers after sending out invoices, a line of credit can help you cover any gaps.”
Highly Adaptable Financing
Some loans are known for being dialed in on designated uses. For example, startup loans, equipment financing, and commercial mortgages are designed for specific types of purchases and expenses. If your needs fall within these limitations, you’ll benefit from the customized nature of these loans because they’re engineered to help you thrive.
On the other hand, there are times when a more flexible financing solution is worth its weight in gold. A business line of credit comes with nearly carte blanche freedom to make whatever purchases your business requires. Whether that’s brooms for your warehouse, cooks for your restaurant, software for your computers, tools for your worksite, or new microwaves for your breakroom, you’ve got the money necessary to make it happen.
A business line of credit simplifies your life because it’s a revolving form of credit. This means that instead of borrowing a lump sum of money from the lender, you get access to a set amount of money. You dip into this pool of money whenever you need to and then repay that amount. As soon as the money is repaid, you’ll once again have access to the full amount of money.
One of the biggest benefits to this setup is that unlike a traditional loan, you only pay interest on what you spend versus the entire amount you’re approved for. For example, if you were approved for a $50,000 term loan with an interest rate of 8%, you’d owe that much interest on the full amount for the entire life of the loan. If you were approved for a business line of credit of $50,000 but only spent half, you’d pay interest on $25,000.
Does this structure sound familiar? If you’re like most Americans, you have at least 1 personal credit card in your wallet. And that card functions in much the same way. Regardless of how much your card is approved for, what matters how much you spend on the card. So if you purchase a $2,300 television to watch the Super Bowl, you’ll make payments (with interest) only on $2,300.
Because a business line of credit is so flexible, small business owners often use it as a safety net. When things are going smoothly, there might be no need to leverage it. But when expenses arise, you’ve got instant financing on tap.
Factors to Consider
Always pay attention to a business line of credit’s limit and interest rate, as well as your ability to consistently make payments on the amount you borrow. If these elements are in harmony, your line of credit will be one of the most stress-free forms of financing available.
At the end of each billing cycle, you’ll have the option of either paying your full balance or making a smaller payment and carrying over the remainder into future billing periods. If you opt for a carryover, you’ll owe interest on that amount. Your goal should be to pay it down as quickly as possible, ensuring you pay less in interest and keep your credit utilization healthy.
While a business line of credit is a popular way to access a line of credit, many small business owners also opt for a business credit card. Here are some of the key highlights both options offer:
Business Line of Credit: With a line of credit, you’ll receive access to an amount ranging from $1,000 to $500,000. You can expect the money to become available in about a week’s time. The interest rates for a line of credit start around 8% and cap out around 24%, and the loan terms have a 1–2 year maturity.
The qualification standards are borrower-friendly with a business line of credit. If your business has been in operation for at least 6 months and brings in $50,000 or more annually, you’ve already got your foot in the door.
Additionally, a lender will scrutinize your credit score. While some loans are only available to people with scores above 700, you’ll find that many lenders will work with you even if your score is in the range of 560.
Depending on your financial history and the details of the financing, you may be asked to personally guarantee your business line of credit. This arrangement is called a secured line of credit and requires you to attach a personal asset to the financing, such as a vehicle, home, or bank account. As long as you make all of your payments, this provision is merely a formality. But in the unfortunate situation where you default, the lender would take possession of your property in order to be compensated.
If your business has strong revenue and a secondary source with which to make loan payments, you can sometimes get approved for an unsecured line of credit. In this scenario, you get access to the agreed-upon limit, and there’s no need for you to risk your personal property.
Business Credit Card: While a business line of credit is considered user-friendly in the financing world, a business credit card is even simpler. As mentioned earlier, nearly everyone already possesses a credit card and is familiar with how they work. So all you’re doing in this situation is applying your understanding of the process to a business setting.
A business credit card can give you a limit of up to $500,000 for your business. The best interest rates start at 8%, though it’s not uncommon for them to trend closer to 24%. The money usually becomes available in a couple of weeks and the loan terms have a 1–2 year maturity.
Your credit score usually needs to be at least 680 to be considered for a business credit card. Additionally, your business will need to have an established financial history and show that it is bringing in reliable revenue.
If you’ve ever filled out a personal credit card application, you know that they’re not particularly difficult. Business credit cards fall into the same camp, with minimum paperwork required and few hoops to jump through. Compared to the tedious process of obtaining an SBA loan, a credit card application is definitely a walk in the park.
The perks of a business credit card aren’t limited to the application process. Each time you use your card, you’ll build your credit. Better yet, you can also leverage the rewards programs that are included with most major cards. Whether you choose cash, gift cards, travel points, or something else entirely, it always feels good to get rewarded for making a purchase you would’ve had to make anyway.
“A business credit card can be much more than a convenient way to pay for purchases,” says Forbes. “These cards can also provide lucrative rewards, superior fraud protection, and smooth out cash flow. According to the Federal Reserve’s 2019 Small Business Credit Survey, 52% of firms with 1 to 499 employees use credit cards on a regular basis.”
Choosing the Best Option
Although it can be fairly easy to apply for a line of credit, that doesn’t mean it’s simple to select the best one. You’ll need to create a shortlist of options, then give yourself plenty of time to do your due diligence.
Start with a business plan that identifies exactly how much money you’ll need. Once you’ve settled on this amount, there’s a natural weeding out that occurs because some of the options might not be able to deliver what you require.
“In order to get a small business loan from just about any lender, you have to prepare a good business plan,” says The Balance Small Business. “In fact, until you have a good business plan, chances are you won’t even know how much money you need or how fast you can repay it. The business plan is in addition to the loan application required by the financial institution.”
Next, you’ll want to pay close attention to the interest rates and repayment terms for each of the options. Even if you’re planning on paying your balance in full each month, your situation can easily change in the future and you could find it necessary to carry over some of the debt. For this reason, it’s crucial you choose an option with a favorable interest rate.
An issue that many small business owners encounter is that lenders don’t always list their disclosures in the same way. For this reason, it can be difficult to compare interest rates and other metrics. If you ever find yourself struggling to understand the details of any financing, consider using SMART Box™ (Straightforward Metrics Around Rate and Total cost), which is a resource created by the Innovative Lending Platform Association.
“Access to capital is a top priority for NSBA and we appreciate how SMART Box allows small businesses to more fully assess and compare lending options,” explains Todd McCracken, president and CEO of the National Small Business Association. “This type of price transparency, along with best practices like the ones adopted by the Coalition for Responsible Business Finance (CRBF), will help solidify the trust between non-bank lenders and small businesses.”
By taking the time to study each financing option, you’ll potentially save yourself a major headache on the back end. Every business has its own needs, so there’s no magic bullet that’ll work for everyone. The goal is to find the line of credit that checks all your boxes and potentially delivers some extra perks.
Making Your Application Shine
When you’ve found the best financing option for your business, whether it’s a business line of credit or a business credit card, it’s time to dig into the application. Because the applications associated with these financing options are simpler than most, it might be tempting to treat them with less care. That would be a grave mistake, as lenders are still going to analyze every detail you send them. Just because the application is streamlined doesn’t mean it’s any less consequential.
The best way to impress a lender is to follow their request exactly. The lenders reviewing your application have no personal reasons to reject your request. They may even go into the review wanting to help your small business. But if you fail to follow the simple directions, how can they be expected to trust you with large sums of money?
On the flipside, when your application delivers exactly what a lender has requested, it’s a physical manifestation of your reliability and attention to detail. So view each request on the application as a necessity. Every financing option has its own requirements, but here’s a list of some of the basic documents you might need to round up when you’re pursuing a small business loan:
- Business plan
- Projected financial statements
- Personal and business bank statements
- Credit reports
- Details of potential collateral
- Business licenses and registrations
- Articles of incorporation
- Personal and business tax returns
- Personal financial statements
- Personal background information
- Copies of contracts with third parties
- Franchise agreements
- Commercial leases
In addition to your careful handling of the application, you can do other things to make yourself a strong candidate for financing. Chief on this list is improving your personal and business credit.
According to Forbes, lenders look at your credit scores as “algorithms that attempt to predict whether or not you will repay your obligations in the future.” Your credit algorithm factors in things like how regularly you pay your bills and whether or not you carry large balances month to month.
The 5 most important factors are:
- Business revenue trend
- Personal debt usage
- Business debt usage
- Business debt coverage
- Personal debt coverage
The higher your credit scores, the better your interest rates and repayment terms will be. So this is an area of focus that can have a significant impact on your finances, with positive changes potentially saving you thousands of dollars in interest over the life of your chosen financing.
One of the most effective ways to keep your score healthy is to actively monitor your credit with the 3 major bureaus. Research shows that 1 in 5 people have errors on their reports, which can drag down their scores and cause real harm. Don’t let this happen to you. Visit TransUnion, Experian, and Equifax and make sure your record is accurate. When you find mistakes, take immediate action to get them corrected.
You might also want to consider working with a credit repair expert. These individuals are trained to help you find the most impactful strategies for improving your score. So if you find yourself feeling stuck, you’re not alone. Plenty of resources are available to help get your credit where it needs to be to get the financing your small business needs to thrive.