Basics of a Business Line of Credit
A business line of credit is a flexible financing option that helps businesses maintain a consistent cash flow. A line of credit consists of a pool of funds to draw from, and you are charged interest on the amount that you withdraw. Businesses can use lines of credit to handle cash flow gaps, manage working capital, invest in projects, and address sudden emergencies or opportunities.
Both traditional banks and alternative lenders provide a business line of credit. Alternative lenders provide you a business line of credit based on different criteria and often much quicker and easier than traditional banks can.
How Does it Work?
Business line of credit is quite similar to a credit card. A lender gives you access to a specific amount of funding set by a credit limit that you can withdraw from whenever you want. As stated earlier, interest will only be charged on the amount withdrawn. You pay for what you use and there are no fees for repaying early. Some lenders may charge maintenance fees however, if you do not use your line of credit for an extended period of time.
Business lines of credit are different from term loans, which provide a one-time lump sum of cash upfront that is repaid over a fixed period of time. With a business line of credit, you can reuse and repay a line of credit as long as you repay the amount drawn and the amount drawn is within the credit limit. Business lines of credit are also smaller than term loans in terms of loan amount, with the borrowing limit typically between $1,000 and $250,000.
There is considerable flexibility in terms of how the funds from a business line of credit can be used. Businesses typically use business lines of credit for:
Supplementing seasonal demand
Covering cash flow gaps and periods of low sales
Covering costs for sudden opportunities/emergencies
Making large purchases
Paying off bills early for discounts and other bonuses
Secured vs Unsecured Line of Credit
A secured business line of credit is a line in which the borrower puts up collateral as a security deposit on the line of credit. Collateral can be inventory, equipment, real estate or other assets that lenders deem eligible as collateral. By providing collateral, borrowers can potentially get higher credit limits at a lower rate as the lender is taking on less risk.
Unsecured business lines of credit do not require collateral assets. Although this can expose lenders to higher risk, they can protect themselves by reducing credit limits, charging higher interest rates, shortening repayment terms, or requiring a personal guarantee.
Qualifying for a Line of Credit
Lenders will look at your business’s history, your business and personal credit scores, annual revenue, cash flow, tax returns, and financial statements to determine whether your business qualifies for a line of credit.
Note that it is notoriously difficult to get a business line of credit from a bank because it is actually against the interests of banks to issue a business line of credit. That the borrowers can withdraw any amount whenever they want and interest will only be charged on the amount withdrawn is disadvantageous to banks, because they would need to have a set amount of money reserved for your line of credit and can only charge interest on the amount withdrawn. Instead, banks would prefer to issue term loans because they can charge interest on the entire loan amount.
For these reasons, businesses usually have to turn to alternative lenders to get a business line of credit. While alternative lenders are more likely to have less strict criteria than banks and will provide quicker funding, it is still relatively difficult to get a business line of credit from alternative lenders - albeit much easier than getting it from a bank.
Accel Business Funding has provided business loans and business lines of credit through asset-based lending, and has funded many businesses for more than $380 million. When banks say NO, we say YES to funding in 24 hours!