What is a business line of credit?
If you need capital to grow your business, you have a few different options. You could take out a loan, get a corporate credit card, or work out a deal with investors. However, there’s also another choice that many founders aren’t aware of: business line of credit.
While business lines of credit are similar to credit cards, there are also some critical differences between the two. In this article, we’ll explain what a business line of credit is and when it could make sense for your business.
How does a business line of credit work?
After opening a business line of credit, you’ll have access to a set amount of credit that you can draw on at any time. Of course, you’ll have to pay that money back along with any interest as laid out in your credit agreement. Like credit cards, business lines of credit are also subject to credit limits.
With a business line of credit, you’ll withdraw funds as cash and pay them off according to the credit agreement. This means that you can use them to cover purchases that can’t be paid off with a credit card.
Your creditor may also charge other fees on top of the interest itself:
- Origination (account opening) fees
- Monthly or annual maintenance fees
- Draw fees on withdrawals
How to get a business line of credit
Like any other form of credit, banks decide whether to extend business lines of credit based on the customer’s creditworthiness. You should expect your application to be evaluated based on some of the following factors:
- Credit scores: Lenders will generally look at both your personal and business credit score to determine the level of risk. Higher credit scores will enable you to access lower interest rates and other favorable terms.
- Operating history: You’ll probably need a track record of at least six months in business in order to get approval for a business line of credit. Some banks may prefer companies that have been operating for a year or two.
- Revenue: Lenders want to see that you’re bringing in enough revenue to cover credit payments. Revenue requirements will depend on the specific bank as well as the amount of credit you’re looking for.
Finally, you’ll have to provide business assets as collateral in order to get a secured line of credit. We’ll take a look at the differences between secured and unsecured credit in the next section.
Secured vs. unsecured credit
A secured line of credit is guaranteed by the company’s assets, which reduces risk for the creditor and leads to more favorable terms including lower interest rates and credit requirements. Of course, this also means that your business assets could be seized if you fail to make payments.
On the other hand, an unsecured line of credit doesn’t require any collateral from the business. Instead, the creditor may ask you to act as a guarantor, which would transfer the liability to your personal assets. They will also likely charge a higher interest rate to compensate for the additional risk. Keep in mind that it may be difficult to get an unsecured line of credit if you have poor credit.
Is a business line of credit right for you?
With so many different types of credit available, it can be tough to determine which one makes the most sense for your business. Let’s take a look at the advantages and disadvantages of business lines of credit compared to other common types of credit.
- Lower credit requirements: In general, it’s easier to secure a business line of credit than it would be to get a traditional business loan. This makes lines of credit a good option for companies that don’t have the revenue, credit history, or time in business to qualify for a business loan.
- Cash withdrawals: Unlike a corporate credit card, a business line of credit puts money directly into your bank account. You can use those funds to make ACH transfers, cash withdrawals, or other transactions that aren’t available with a conventional credit card.
- Flexibility: After getting a business line of credit, you can withdraw funds as needed throughout the draw period. That’s a significant advantage over a traditional business loan, which provides the full amount upfront and doesn’t allow for subsequent withdrawals.
- Higher interest rates: While business lines of credit usually come with lower interest rates than credit cards, the rates are still typically higher than those associated with a business loan. If you’re concerned about interest, consider applying for a conventional term loan.
- Shorter terms for repayment: At the end of the draw period, your balance will be fixed and you’ll have to start paying it back. As we saw with interest rates, repayment terms are often shorter for lines of credit compared to business loans. This means larger payments and a greater impact on cash flow.
- Inconvenience: One major benefit of a business credit card is that you can simply swipe or tap at the point of sale and then pay off the purchase later. With a line of credit, you’ll have to request a withdrawal and wait for the funds to transfer before you can use them. Note that some banks may also charge a fee each time you withdraw.
Other funding options
Fortunately, startup founders have more options than ever when it comes to funding. We’ve already discussed term loans and corporate credit cards, but here are a few more alternatives — these could help you get the cash you need if you don’t yet qualify for a business line of credit:
- Capchase: Capchase offers non-dilutive financing for SaaS companies, helping founders extend their runway and fill cash flow gaps without giving up any equity. We’re giving customers 15BPs off non-dilutive growth financing through our partnership with Capchase.
- Foundersuite: Foundersuite provides a database of 141,000 VC funds, angels, and more — plus a CRM and Investor Update tool to help you communicate with potential investors. Firstbase users get an exclusive 10% discount on any annual plan.
- Outfund: Outfund makes funding simple by replacing interest payments and hidden fees with a single flat fee. Get 10% off the initial fixed fee when you apply for financing through our Outfund partnership.
Business lines of credit offer a variety of benefits for startup founders including flexible cash flow and lower credit requirements. At the same time, there are plenty of good alternatives including loans, credit cards, and the startup-focused options mentioned above.
Ultimately, it’s up to you to identify the kind of financing that best aligns with your business goals. Whatever type of funding you’re looking for, you’ll most likely need to incorporate your company in order to create a legal entity and start building credit history. Click below to start your US incorporation and take the next step for your business.