What is a Business Line of Credit & How Does it Work?
Every small business must be able to adapt to change, especially during times of uneven growth or cash flow. When you need quick access to cash and flexible repayment terms, an unsecured line of credit can often be the ideal solution.
What is a small business line of credit?
A small business line of credit has more in common with a small business credit card than a small business loan.
As a small business loan, an unsecured line of credit provides a business with access to funds that can be used to address any business expenses that arise. Unlike a small business loan, however, a lump sum is not paid when the account is opened and requires a subsequent monthly payment.
A small business line of credit is subject to an annual credit review and renewal and is revolving, like a credit card: interest starts accruing as soon as the money is withdrawn, and the amount you pay (without interest) is available to borrow again as you pay off the balance . As with a credit card, the lender will set a limit on the amount you can borrow.
Use a small business line of credit
The number one reason for opening a business line of credit is access to short-term financing. Most companies use this money to support the financing of operating expenses such as purchases and payroll or to increase inventory. Cyclical businesses often rely on an unsecured line of credit as a source of off-season working capital.
Unlike many small business loans, an unsecured line of credit isn't set aside for a specific purpose or purchase—it's a good choice for small businesses looking for ways to better manage their cash flow. Funds are typically withdrawn from a line of credit using a business checking account, small business credit card, or even a mobile banking app.
Understanding secured and unsecured lines of credit
A small business line of credit is usually offered as unsecured debt, which means you don't have to provide collateral (assets that the lender can sell if you default on the debt). Many unsecured lines of credit come with variable interest rates and are available for amounts ranging from $10,000 to $100,000.
For amounts over $100,000, you may need to secure your line of credit with a comprehensive mortgage on your assets or a certificate of deposit.
What does it take to get a small business line of credit?
Be sure to research the details of the requirements for any business line of credit for the lender. For example, many banks require that the company be under current ownership for a specified period of time.
Rates on a business line of credit tend to be lower than those on a business credit card, which can charge more than 20% APR on purchases — and even more on cash advances.
Other advantages
Keeping a line of credit in good standing can help build your company's credit rating and put you in a better position to get loan terms if you're looking for future financing. Many small business experts suggest that first-time applicants start with a modest line of credit and pay down debt quickly as a way to build a credit profile.
Keeping your small business finances running smoothly is often a challenge in today's fast-paced world. Depending on your specific business needs, a small business line of credit may be the simple solution you need to meet your growth goals—at a pace that works for you.