Navigating your small business safely through the current economic crisis is easier said than done, particularly when it comes to capital.
Sadly, unplanned expenses or a slump in sales can have long-lasting and dire consequences. Fortunately, there is a wide range of alternative financing options available that can act as a veritable lifeline, giving you financial flexibility and access to extra cash when you need it most.
One such option is a small business line of credit.
In today’s article, we’ll cover how a business line of credit (LOC) works, why it’s become a powerful financial tool for small businesses (SMBs), and what it can do for your business.
What Is a Business Line of Credit?
A business line of credit is a flexible alternative financing option that can be especially beneficial to startups and small business owners.
It’s a type of revolving credit, meaning that the money is in reserve, accessible whenever you need it, and you can withdraw funds at any time.
What sets a LOC apart from other forms of SMB financing is that you only pay interest on the money that you spend. And depending on your current cash flow, you can either pay your balance in full or make the minimum payments of accrued interest and pay your balance over time.
Either way, as soon as you pay down your line of credit, those funds become available to you again. You can continue to use the LOC as long as you maintain regular payments and don’t exceed your credit limit.
Business Line of Credit vs. Credit Card
While there are many similarities between a LOC and a business credit card, they serve different purposes.
Credit cards usually carry a higher interest rate, including fees for cash withdrawals, and place restrictions on what you can use the account for.
That’s why business credit cards are best suited for small ongoing expenses you can pay in full monthly, to earn rewards or cash back.
Conversely, a small business line of credit has more qualification requirements, so new businesses may have an easier time getting a credit card first, establishing their credit history, and then seeking a LOC.
How Does a Business Line of Credit Work?
Once you’ve been approved a LOC, you’ll typically receive access to your funds through a business checking account, with the credit limit stipulated in your contract.
Interest only accrues over the money that you draw—either by withdrawing or purchasing.
Do keep in mind that a LOC’s annual percentage rate (APR) generally ranges anywhere from 8% to 30%, so shop around for the best option. Interest rates themselves depend on your credit score, your business history, and the lenders’ current offerings.
As soon as you make your first draw, you can then repay the amount you used plus its interest, and those funds will become available again.
To give you an idea of how it works, let’s say that you secure a small business line of credit for $100,000 with a 10% APR.
You make a $20,000 purchase, and thus owe $2,000 in interest. You can pay off the $22,000 in full or make regular payments—as soon as you do, your credit line is back to the full amount of $100,000.
Benefits of a Business Line of Credit for SMBs
Once you get the hang of how to use your small business line of credit, you can start capitalizing on its unique benefits. Here are five of the most significant.
1. Keep Business Finances Clear
Startups and new businesses often learn the hard way the importance of keeping personal and business expenses separate. A business line of credit keeps your company’s finances neat and organized in one place, far from your personal finances, so you can easily track your spending, cash flow, and ROIs.
2. Manage Cash Flow With More Flexibility
Unlike a loan, you can draw funds on demand from your business line of credit, for any expenses, emergencies, or investment opportunities that may arise. Noticeably, it can serve as an important bridge for cash flow gaps that might occur between accounts payable and accounts receivable.
3. Build a Solid Repayment History
If managed responsibly, a small business line of credit can help you establish a strong repayment history. By making on-time payments over long periods, you set the foundation from which you can access bigger financing and loan options, and even get better interest rates.
4. Pay Less Interest
The average personal loan or credit card can charge high-interest rates (plus sneaky fees) for startups or those with less-than-great credit. With a small business line of credit, you typically get more competitive interest rates.
5. Nurture Relationships With Lenders
When you prove to be a reliable borrower, your lender will be enticed to offer you more credit, better interest rates, and improved terms of agreement.
How To Qualify for a Small Business Line of Credit
Applying for a small business line of credit is pretty straightforward. It typically boils down to four steps.
1. Consider Your Needs
You must first consider whether a small business line of credit is the best option for your business—it’s not a one-size-fits-all financing solution.
For example, if you need to make a large purchase or need a lot of capital, there might be better options available, like a merchant cash advance.
You must also figure out how much credit or cash flow you need to cover.
2. Choose a Lender
Once you’re set on opening a LOC, and decided how much credit you need, carefully study your options.
Choose a reputable, responsible lender that offers terms and rates that you’re comfortable with. Ask if the line of credit is on fixed terms, or if it renews annually. If it’s the latter, check whether there’s an annual fee—some lenders will offer incentives to waive it.
3. Review Your Qualifications
Review your personal and business financial records, like how long you’ve been in business, annual revenue, and credit score, to determine what lines of credit you can qualify for.
Lenders will also assess these qualifications when evaluating your eligibility and interest rate. Typically, online lenders are more lenient with their requirements than banks, which often impose stricter criteria for qualifications in exchange for lower average APRs.
4. Apply and submit documents
The application process and required documents will vary depending on the lender you choose, but you can anticipate that most SMB financing processes require personal and business tax returns and your recent bank statements.
Some lenders also ask for a balance sheet or profit and loss statements. Depending on the amount of credit you request and your company’s history, lenders may require additional steps for securing the LOC, such as signing a personal guarantee or requiring that you put up collateral.
Depending on your lender, it can take between 24 hours to a couple of months to complete the application, underwriting, and funding processes (with banks taking the longest.)
Tips for Managing a Small Business Line of Credit Responsibly
Once you’ve secured your business line of credit, it’s essential that you manage it well. Here are a few tips to get you started:
- Be strategic about what you spend: only take what you need, and consider the payback amount.
- It’s best to keep the percentage you spend relatively low compared to your total credit limit—less than 30% is ideal.
- Pay off your balance as quickly as you can, to save on interest.
- Even if you plan to pay your balance in full, know your minimum monthly payment, to ensure you can comfortably meet payments.
- Only ask for a credit line increase if it makes sense in your unique case.
A small business line of credit can be a powerful tool to grow your business and build a solid financial foundation—just make sure you’re responsible while using it.
Small Business Line of Credit FAQs
Every business owner seeking alternative financing options is bound to have some questions. Here are the ones we frequently get concerning small business lines of credit.
1. What Can a Business Line of Credit Be Used For?
The beauty of a LOC is that it can be used for whatever you decide your company needs. Typical uses include covering short-term expenses like payroll, inventory, and cash flow gaps.
2. When Is a Business Line of Credit a Good Idea?
A small business line of credit is ideal if you need flexible and bespoke SMB financing. A business loan or an MCA might be better options for SMBs seeking a large lump sum.
3. How Long Does It Take To Get Approved?
With so many different financial lenders offering credit lines, approval times can vary significantly, ranging from one day to several months.
4. How Long Do You Need To Be in Business To Get a Line of Credit?
Most lenders ask for at least one or two years in business—some online lenders are willing to work with newer companies, whereas banks are generally stricter. The longer a business has been operating, the more stable and appealing it is to lenders, and this can garner lower interest rates.
5. How Can I Increase My Credit Limit?
Showing your lender steady revenue and growth can benefit your chances of getting a higher credit limit. Above all, maintain a consistent repayment history with your lender.
Nexi: Your Partner in SMB Financing
If you’re in need of SMB financing, it’s always smart to consider all the options at your disposal, including what you need the funding for.
Only then go for it.
Whether it’s an MCA, or another form of alternative lending, Nexi sets the standard of excellence in responsible financing, helping ambitious small business owners to achieve their big goals.
And we’re here for the long haul—we proudly provide fast, flexible funding to countless industries across the entire United States.
Contact us today, and learn how we can help your business.