Understanding Business Lines of Credit & Requirements From a Bank
If you are reading this, you are probably considering getting a small business line of credit, or are interested in financing options for your business expenses. On the other hand, maybe you are just a person who is generally curious if you will qualify for a business line of credit or business credit card.
Maybe you are even considering becoming a business owner and are wondering what business owners have to go through in order to get their hands on a line of credit. This process can seem overwhelming at first, but by the end of this article, you will have gained a new insight all the things banks look for when considering businesses for a line of credit, or even a business term loan.
How Does the Economy Affect Borrowers?
The first thing you should know is that depending on how the economy is at the time, it may influence how hard or easy it is for you to get a line of credit. What this means is that when the economy is struggling, you may also struggle to get your hands on a loan or line of credit, and the overall approval process is much more rigorous. For example, back during the 2008 recession, business owners were having a very difficult time getting their hands on a lump sum business loan, or even a line of credit.
As of the current COVID-19 impacts on the economy, business owners are currently facing similar difficulties to 2008. It may not even matter how high your business or personal credit score is, how much business assets you own, or what you can provide for collateral. On the flip slide of that, during times where the economy is thriving, it may be easier for you to get approved for a line of credit. Additionally, you may even qualify for an unsecured business line of credit. Unsecured lines
Bank Lenders Typically Require Collateral
With that being said, no matter how the economy is doing, it is always helpful to have collateral. What is collateral as it relates to a business line of credit? Banks typically require that 100% of your business credit line will need to be backed up with collateral. Business collateral usually looks a little different than personal collateral. Business collateral could be inventory, accounts receivable, buildings, equipment, etc. Personal credit typically could come in the form of equity in real estate, stocks, bank accounts (savings or checking accounts), mortgages, cars, etc. Regardless of if you are trying to get a personal or business line of credit, if you have no collateral the bank will not approve your credit line.
If you are thinking about starting a business, obtaining a line of credit might be best for short-term working capital needs. This could be a beneficial choice when hiring new employees or buying any new business equipment.
What if your new business ends up defaulting? What if you can’t pay back your small business loan or credit line? That’s what a personal guarantee is for. As a baseline, unless you have a large business of $10 million or higher in annual revenue, you will be required to sign a personal guarantee.
In short what this really means is that if the business defaults, the bank has access to your personal assets for repayment. If you have multiple partners in your business, all business partners will be required to sign a personal guarantee (PG). Something to keep in mind is that all owners of your collateral will be required to sign the personal guarantee. This means that both you and your significant other will be required to sign and share equal responsibility. This can also present itself as an issue for you. Essentially you are going to be risking your personal assets for your business.
How is your Credit score?
Another thing that will be looked at when trying to get a business line of credit is your personal credit score. You will have to have a credit score of 680 or higher. Traditional lenders like Bank of America, online lenders, or any other type of credit union will want to see that you are credible and trustworthy. For small business owners this can be quite easy to run into issues. For example, having a low credit score will definitely create a roadblock for you. Another thing that may create an issue if your significant other has a low credit score or credit history. Also, keep in mind that many business owners have problems with having a high credit score because they have put some many of their credit cards in their own name.
What Type of Industry Are You In?
For those in a startup or a fairly new business, it is crucial to take a moment and analyze what industry you are in. During the application process, banks will look at your industry and unfortunately, banks tend to favor some industries such as business to business.
On the other hand, banks tend to give less help to cash businesses, or any business that could potentially give the bank poor PR. If you are in an industry that banks typically don’t favor, your credit limit may not be in your favor, or you may be hit with a large origination fee. Lower interest rates will typically be given to industries that are favored. Banks also tend to rarely give lines of credit to new business owners, so if you fall into that category you may want to consider other options.
Have all Financial Statements/Balance Sheets
Having a good well-organized track record is also important. Banks don’t approve lines of credit to new businesses easily, and even lines backed by the SBA (Small Business Administration) can be difficult to get. Banks want to see cash flow and solid assets, and this means that the way you look at your business is not how banks will look at your business. Make sure your account updates your Income statement/balance sheet before applying. Also when applying in general make sure to keep all personal and business tax returns.
Covenants and Disclaimers to Keep in Mind
If you are approved, keep in mind that the bank will always keep tabs on your debt to sales ratio. With that being said, a bank will require certain ratios be in place or they will cancel your credit line. In the event that the economy goes into a major recession, the bank can ask for updated financials and can lower or cancel your line of credit. This can also happen if you miss a monthly payment. The major take-away here is to maintain organized and always be ready to provide any additional documents at all times.
Costs Associated With Business Financing
Banks will charge to set up your line of credit (origination fee) and will also charge an annual fee for maintenance. Even if you don’t plan on using your bank line of credit right away, keep this in mind because there will be fees even if you are not using it immediately. Knowing all this information about what banks look for in a business owner, the application can be extremely tedious and timely. With that being said, it is imperative and in your best interest to have all your documents on hand such as personal financial statements, business balance sheets, income statements, tax returns, and anything else that may be helpful. The more information you put down, the better. Try to be as accurate as possible too.
Final Take-Away for Small Business Owners
When you are looking for a line of credit, make sure you are well prepared prior to applying, especially with a commercial or local bank. If you are approved, make sure you read all of your terms and conditions. Your line of credit may be subject to periodic review and changes. This may include credit limits and pricing reductions, credit limit and pricing increases, or account closures. Whether you are looking for a small business term loan or a line of credit, it has never been very easy for banks to hand out money to unqualified customers.
About Financing Solutions Business Line of Credit
Financing Solutions business line of credit costs nothing to set up, nothing until used and when used, is inexpensive. The credit line requires no collateral and no personal guarantees.
Organizations will set up the line of credit in advance so that if there is ever any cash flow issues, you will have a cash back up plan. The time to set up a credit line is when you don’t need it so that it is ready to be used, just in case.
If you would like to see if your organization would-be approved and for how much, please feel free to fill out the no-obligation, 2-minute line of credit application here.