As a business owner, you've likely received dozens of offers for various business lines of credit. They come in the mail. They come via email. They come on the phone. They pop up on your social media feeds. They are Big Business with a capital "B."
Business lines of credit are a successful financial product because they can provide valuable assets to a growing company like yours.
But they come with disadvantages and risks. In this article, we'll look at both sides of this coin to see if a business line of credit is right for you.
What Is a Business Line of Credit?
Of the financial products, you're probably familiar with, a business line of credit is the most like a business credit card. You receive a maximum balance and take money from that balance as you need it. Each month, you make a minimum payment based on the current balance of the loan.
A business loan, by contrast, works more like a mortgage or car loan: A bank lends you a lump sum one time, and you make regular payments each month until it's paid off.
Business Lines of Credit: Pros
As we said before, there's a reason small business lines of credit are popular. They can provide distinct and valuable advantages to your business. Among the most important are:
1. They Even Out Cash Flow
All businesses, but especially small business, sometimes need to engage in a juggling act when income lags slightly behind expenses. A business line of credit lets you pay your bills on time and take advantage of automatic payment discounts.
Similarly, seasonal businesses can benefit from a line of credit when the cash influx from peak times isn't quite enough to make it through the leaner months. You can draw from the line when it's slow, then pay it down when the crowds return.
2. They Allow You to Pay for Only What You Need
A business loan gives you a lump sum based on what you think you need for your business. It's rarely precisely the right amount.
If you guess low, you have to scramble to find the extra capital to accomplish your goals for the business. This quick credit tends to be expensive and time-consuming to get.
If you guess high, you're paying interest and initiation fees on money you didn't need to borrow. That makes the entire investment less efficient and can spell real trouble if the loan has early payoff fees.
With a line of credit, your maximum balance is your highest estimate of the costs you need to cover. However, you use only what you need, meaning you only pay interest on what you need.
3. They Enable You to Seize Opportunities
Sometimes your business has an opportunity to advertise, participate in an event, open a new location, or take advantage of bulk price points for supplies and inventory. If your cash flow is weak at the time, you miss that opportunity.
With a line of credit on hand, you can take advantage of those opportunities every time they're the right decision.
4. They Help You Build a Relationship With the Lender
Lines of credit are similar to credit cards in many respects, but they often require extra steps to access the balance. Those steps usually put you in contact with a decision-maker or customer service representative at the bank or credit union that issues the loan.
That regular, personal contact makes it easier for you to get other loans with the same institution later. The next time you need a new company vehicle, equipment loan, or to raise the limit on your line of credit, the process will be streamlined, and the terms will likely be better.
Business Lines of Credit: Cons
Nothing in life is perfect, and business lines of credit are no exception. Though they have some strengths, they also come with weaknesses, hassles, and risks. Consider the following carefully as you make up your mind about taking one on.
1. They Can Be Expensive
Although they're not usually as expensive as a business credit card, business lines of credit have high-interest rates. These are generally in the double-digit APR range, sometimes over 20%.
In addition, many business lines of credit carry hidden initiation, processing, and maintenance fees — not to mention non-sufficient funds (NSF) and late payment penalties — that increase the cost significantly. Read the fine print carefully before accepting one.
2. There Are Wolves
It seems like every decade has its top-tier financial scam. The 1980s had junk bonds. The 2000s had sub-prime mortgages. The 2010s have business lines of credit.
To be clear, not all business lines of credit are a bad deal run by predatory institutions who want nothing but to milk your business of its hard-earned revenue. Many are legitimate, fair business deals, especially those from established banks and credit unions.
But some are offered in bad faith, with extreme rates of interest and predatory policy details. Be wary, especially of offers that come to you rather than waiting for you to come to them.
3. Applying Is Time-Consuming
To apply for a legitimate business line of credit, you will need to provide:
- Business bank statements
- Personal bank statements
- Personal tax returns
- Business tax returns
- Recent profit and loss (P&L) statements
- Business documents (such as articles of incorporation)
- Resumes for leadership
It's a long process with lots of moving parts, far more complicated than applying for a secured installment loan or credit card.
4. They Can Lead You Into Temptation
Remember how we mentioned that a business line of credit lets you act on opportunities? Not every opportunity is a good one, and if you act on too many at once, you may not leverage any of them as much as you should.
It can be surprisingly easy to "accidentally" borrow too much against your business line of credit and spend your profits on interest payments. Consider these lines only if you have the financial systems and discipline to avoid this kind of spending hazard.
5. Limits Can Be Low
Business lines of credit usually have limits higher than a credit card but much lower than an installment loan. If the line has a limit lower than your needs, it's not a very good solution. It just sets you up to accumulate debt without accomplishing your goals.
There is no universal yes-or-no answer to whether or not your business will benefit from taking on a business line of credit. Each business is unique, and each situation is different.
But if you consider the information above carefully, you'll be able to make the right decision for your company regarding this helpful but risky financial tool.
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Funded, in part, through a Cooperative Agreement with the U.S. Small Business Administration. All opinions, and/or recommendations expressed herein are those of the author(s) and do not necessarily reflect the views of the SBA.