What is a Business Line of Credit and How Does it Work?

What is a Business Line of Credit and How Does it Work?

Being one of the best places to go for business financing, a business line of credit gives you access to funds whenever your company needs a boost in financing.

Similar to a credit card, a business line of credit lets you withdraw funds when you need them. You also only get to pay interest on the total amount of money borrowed for your business.

What is a Business Line of Credit?

A business line of credit provides your company with a specific amount of funds that you can use to finance short-term operating expenses, such as payment of suppliers and meeting employees’ payroll.

This is usually provided by a bank or credit card institution.

You only pay interest on the cash withdrawn from your lender. You don’t pay interest on the money you leave in the bank untouched.

Generally, you will find out that a business line of credit stays open indefinitely, so you’d be able to draw from it as needed, without having to reapply for more financing.

The bottom line is that with a business line of credit, you have a revolving pool of capital at your disposal.

There are basically two (2) types of lines of credit for businesses:

  1. A secured line of credit
  2. An unsecured line of credit

Secured Line of Credit

The secured business line of credit will require your company to provide some form of collateral to secure financing.

Collateral typically comes in the form of an asset that the lender can take full ownership of and liquidate to pay off the debt settlement in the event of a default.

A secured line of credit offers lower interest rates to customers and more flexible payment terms. This type of line of credit is best for new companies that lack a financial history or the needed proven track record to qualify for an unsecured line of credit.

Basic Requirements:

To qualify for a secured business line of credit, you must meet the following basic requirements:

  1. You must be willing to provide some basic information that relates to both you and your company. Some of these include your name, valid address, the name and nature of your company, the start date of your company, total number of employees, the annual gross sales and cumulative profit of your company, and so on.
  2. Small business lenders may also require your company to have been in operation for a total certain number of years, as well as a minimum yearly revenue amount.
  3. Collateral that may include any of your company’s assets such as real estate or a certificate of deposit (CD).
  4. A good credit score for both you and your business.
  5. A good debt to credit ratio.
  6. You will also be needed to state what your company is going to be using the business line of credit for.

Unsecured Line of Credit

An unsecured business line of credit, on the other hand, can be obtained without collateral. This simply means that if your company happens to default on the financing, the lender will have no pledge securities to use to recoup any losses.

  • Now, this sounds risky on the part of lenders, but still, business line of credit lenders have unsecured credit lines to protect themselves by other means. Some of these include:
  • Providing lower credit limits to new customers
  • Charging higher rates on their business line of credit
  • Shortening the repayment or settlement period
  • Requiring a personal guarantee commitment

Note that an unsecured line of credit might also require a general lean on your assets, which in turn, gives them the right to seize all of your assets in case things don’t work out with your settlement.

How Does a Business Line of Credit Work?

A business line of credit is a lot like a credit card for your business. Thus, it’s best not to think of it as a business loan.

When you open a line of credit for your business, your bank or direct lender will usually start sending you a monthly statement showing you how much funds you’ve taken out so far, the total interest rate that is to be paid, and your borrowing limit.

The average accrued amount for a small business line of credit is usually around $100,000, and of course, this is totally dependent on your (the business owner’s individual circumstances, credit rating, the type of business you run, and the steady revenue your business generates, and so on.

Once you draw money from your lender, your business will usually have to start making a weekly or monthly payment to repay the line of credit, including interest payments.

Now, some banks have fees to set up a line of credit. They may also have additional fees such as transactional-based fees, and an annual fee.

Thus, this is something you will need to clarify with the lender of your choice.

Business Loan vs Line of Credit

The difference between a business line of credit and a typical small business loan wills down to flexibility.

A small business loan is best for large sum lump of investments in your company’s new equipment purchase, real estate, inventories, and other single expensive assets that your company will hold for a long period of time.

Small business loans usually have higher interest loans than lines of credit, and usually require that you secure them with some kind of personal guarantee or collateral.

On the other hand, a business line of credit is all about cash flow and investing back into your company.

So you can have access to funds at any time for your business, and only get to pay back that exact amount you took out.

Conclusion

When opting for a business line of credit, it’s always best you pay attention to what kind of credit line your bank or lender is generally offering you.

For instance, if your financial institution is asking you to fill out a UCC-1 financing statement, this simply means they would want to put a lean on your assets.

In such as case, you will need to consult with a lawyer to help you go over the terms of the agreement so you know exactly what you are signing, and what you may potentially have to give up.