Your First Small Business Line of Credit: What to Know
Are you seeking growth financing for your small business? Before going into significant debt or taking on investors, have you considered a small business line of credit? A small business line of credit differs from traditional business loans, invoice factoring, short-term loans, and credit card financing in many ways, but most importantly, it could give you the financial cushion you need without requiring your company to jump through the red tape hoops many financial institutions require. For both small companies in the early stages or established businesses, a small business line of credit can be a quick solution for impending cash flow challenges.
Here’s what you should know about your first small business line of credit.
What is a Small Business Line of Credit?
Like a business credit card, a small; business line of credit is a kind of “revolving” business loan that allows the borrower to draw money when needed and pay it back over time. Also, like a business credit card, the borrower is preapproved for a specific credit limit and only pays interest or fees on the amount drawn. Then once the draw has been paid back, there are no fees to pay until the next draw.
Although credit card financing can be helpful in some situations, the interest rates are generally so high, most small business owners only turn to credit cards for funding in extreme emergencies. Plus the amount a credit card(s) allows one to borrow from is often very small. A line of credit for small businesses is better for typical financial situations when, for instance, companies find themselves struggling through a slow sales season or lacking the cash to purchase an essential piece of equipment (equipment financing).
Traditional business loans are “installment credit.” This means the loan is given to the borrower in one lump sum, and fixed monthly payments (which include principal and interest) are required until the loan is paid back in full. Once the loan is paid in full, the borrower needs to apply for another business loan if more money is needed. Because a small business line of credit is revolving credit, the money is always available for the borrower to draw on. As it’s repaid, the money is available to borrow again without applying for a new loan. Lenders usually require monthly or bi-monthly payments, but because the amount drawn is smaller than the entire loan amount, the payments are also smaller.
Secured vs. Unsecured Small Business Line of Credit
Many small business lines of credit require collateral for approval, meaning the borrower must offer up assets as insurance for loan repayment. For instance, in a mortgage credit line, the house is the collateral and how the lender will recoup its losses if the borrower defaults. In a business line of credit, collateral might be equipment, inventory, or possibly personal assets such as the owner’s house or car. The borrower may also be asked to make a personal guarantee, which means if the business cannot repay the loan, the borrower pledges to make the payments.
Lenders offering a small business unsecured business line of credit do not demand collateral to guarantee payment. However, since these unsecured small business lines of credit require no personal guarantee, approval may hinge on other conditions such as more years in business, higher levels of revenue, and better credit scores. You may assume the best small business lines of credit are unsecured but watch out for lenders charging higher interest rates and offering lower credit limits on unsecured loans.
Urgency and Flexibility
Two other differences between small business loans and small business lines of credit are the speed of the application process and the freedom to use the money as the borrower wishes. While a traditional loan may take several weeks (and countless amounts of paperwork) before the borrow hears if the loan has been approved, small business lines of credit can take as little as 24 hours.
On the other hand, business loans are often limited to specific uses and based on the amount needed to buy, for example, a particular piece of equipment or property.
Alternately, a small business line of credit is available to use for whatever business purpose the borrower needs and is available in smaller amounts. It’s always important to read the fine print, of course. Many business credit line lenders charge origination fees or draw fees every time you borrow from the account.
How to Apply
The documents needed to apply for a small business line of credit vary by lender, but in general, you should have the following documentation prepared:
- Recent business tax returns
- Recent personal tax returns
- Bank account information and bank statements
- Financial statements (balance sheet, income statement)
- Federal Tax Identification Number or Employer Identification Number (EIN)
- Social Security Number
- Business entity type (sole proprietorship, partnership, corporation, limited liability company)
- Past loan documentation
You can be sure the lender will also run your business and personal credit scores from at least one of the three major credit bureaus (Dun & Bradstreet, Experian, and Equifax). Therefore, it’s vital that you check each credit report for mistakes or adjustments before applying for credit. Borrowers are legally allowed to receive their personal credit reports for free from the credit bureaus once every 12 months.
Since you won’t know which credit bureau the lender uses for your small business line of credit application, you’ll want to get reports from all three credit bureaus. The three reports will not necessarily be the same since not all creditors report to all bureaus. Review each credit report thoroughly to ensure it correctly shows your credit history. Inaccuracies are common, so make sure you report any mistakes immediately. Each bureau has a dispute process to handle credit report mistakes.
Most lenders have minimum credit score standards, although they may not publicize those standards. Businesses with higher scores usually get better interest rates or lower fees, but some lenders may be willing to work with you to find a mutually beneficial arrangement. If your business is still in the startup phase and you don’t have a lot of business financial records, it’s vital to start building your business credit history as soon as possible. Begin by separating your personal and business finances, apply for different kinds of credit (not just credit cards), and make required payments on time. Lenders want to see responsible financial behavior, and your credit scores will reflect that behavior.
What Happens After Approval
Congratulations on receiving your first small business line of credit! Once you’re approved, your business will gain access to the business credit line almost immediately. Funds will be wired to your business account whenever you need them. As you draw money, the small business line of credit statement will reflect that draw and stipulate a repayment schedule, including any interest due. As we previously stated, depending on the lender, you may also be required to pay other transaction fees.
The repayment periods for small business lines of credit also vary—typically ranging from six months to several years. However, making payments on time is crucial as the lender can decide to call the loan at any time if you are in default. If this were to happen, your business could be faced with a considerable debt negatively impacting (possibly destroying) your company’s future.
Where to Get a Small Business Line of Credit
While many small business owners start their money hunt by searching for the best banks for small business lines of credit, don’t disregard alternative lenders. Applying for a Wells Fargo small business line of credit, Chase small business line of credit, or Bank of America small business line of credit can take hours filling out the applications. And what’s worse, it can take anywhere from three to six months to be approved. Plus, the process can get expensive when you add up all the access fees.
Financing Solutions is an alternative lender offering an easy application process (it takes less than two minutes to fill out) and requires no collateral or documentation for a written offer letter. Other alternative lenders have a much longer application process and can be quite expensive.
The founders of Financing Solutions have started and grown several companies together; therefore, they understand how important it is to keep costs low. That’s why we don’t charge you to set up the credit line, and there are no maintenance fees. We don’t ask for personal guarantees (business lines of credit without personal guarantee), and applicants can receive a no-obligation offer letter the same day. We make approval decisions based on our decade of experience working with small businesses. Are you running a nonprofit business? We are one of the only financial companies that work with nonprofits. Find out today why we have five-star ratings by Better Business Bureau and Google.