A business line of credit (or BLoC) is a way of securing current and future funds for your business, for use in a variety of situations such as:
- Helping to carry over debts until receivables are paid or closing dates are met.
- Emergency funds for when equipment breaks down, acts of nature destroy property, or lawsuits and other surprise liabilities pop up.
- Securing low interest marketing and growth funds for spur-of-the-moment deals and projects.
- As a credit building tool, where you make all your purchases using the BLoC, then pay them off entirely every month or two.
- For financial assistance during one or a few lean months, such as those experienced by seasonal business.
5 Pros of Securing and Using a Business Line of Credit
1. You retain financial control of your business
Many popular startups and established brands dream of the moment where they grow so big it becomes a necessity to approach angel and VC investors for growth capital.
When you’re not that big yet, or just find yourself in a crunch for funds to get by while waiting on inventory to be made or receivables to come in, giving up an equity stake in exchange for funds may not be in your best interests – yet.
You’ll likely have to put some property equity on the line to get a BLoC for any large amount, but that equity is only lost if you default or declare bankruptcy.
2. Increased flexibility in how much you need to borrow at once
With a business loan, you have to specify an exact amount you want to borrow, and interest starts getting charged on that money the minute you cash the check.
Credit cards allow flexibility in how much you can borrow, but interest rates on the best cards are usually north of 14% and most commonly at or above 20% per year, not to mention the extra fees and interest they charge when you need cold hard cash.
Getting a line of credit for your business allows you to be more flexible than other types of business loan. You can comfortably choose how much you borrow at once, at a significantly reduced interest rate (if your credit’s good), and the fees are generally the same across the board whether making a purchase or taking a cash advance out.
3. A business line of credit allows you to increase your credit score
Much in the same way your credit scores can go up dramatically the more frequently you use and pay down your credit cards, the same holds true for a BLoC.
Sure, things like regular mortgage, lease, car, and other bill payments make an impact on your score. However, a line of credit can be paid off within days of each purchase, allowing you to show creditors you’re responsible with your debts.
4. BLoCs a great way to start building trust with lenders early on
Not all lenders require it, but you’ll most likely need to offer collateral at first to secure a business line of credit; definitely when the limit starts inching past $5,000.
However, as you use and pay down your balance, or make the required payments on time, most major banks and lenders will start to extend more credit without the need for collateral.
Best, after you’ve had a BLoC for a while, you’ll find it much easier to secure low-interest business loans, and even lower interest credit cards with a variety of rewards and other benefits associated with them.
5. They’re a great on-demand cash flow source
For all the reasons mentioned above, including the ability to tap into money whenever you wish, at much lower interest rates and fee structures than credit cards, a BLoC is there whenever you need extra funds to make a purchase or pay some bills that are in danger of going past due.
5 Cons of Securing and Using a Business Line of Credit
1. Increased fees over loans or securing investor funds
The biggest concern here comes when selecting a lender to use. Some will charge what seems to be very reasonable interest rates (7 – 25%) over what they can offer on a business credit card. However, when you start adding up the mountain of fees (ie., withdrawal charges and account maintenance fees) that some lenders charge, those interest rate savings quickly disappear.
Make sure you shop around and compare the interest rates with the overall fees that can be charged before settling on one lender versus the next.
2. A business line of credit is a loan that needs to be repaid
And, if you plan to use your BLoC as a credit building tool for your business, you better have a plan to pay it off quickly in order to get the frequent limit increases you’ll likely need as your business grows.
In short, a business line of credit is just like any other debt, it’s a liability and should only be used when you’re sure the money borrowed is coming back in quickly, such as when waiting on receivables from a reliable customer.
3. Not always a viable option for new startups
Most major banks and highly rated lenders won’t touch a new business with less than a positive two-year financial track record. This is just the reality that exists in a world where a new startup is likely to launch every single hour of each day, and 9 out of 10 startups are doomed to fail.
Luckily, there are more lenders out there popping up that are willing to take a chance on new startups, but expect to pay more in fees and interest if you get accepted.
4. You’ll most often have to offer collateral for the amount borrowed – at first
This is true whether you have a longish financial history. If you have no track record with a particular lender, they’ll want equal collateral offered to guarantee the amount of funds you want.
The great news here is that once you establish credit with a lender, by making your payments on time and paying the balance down to zero, they’ll extend you even more credit without the need for equal collateral such as company or personal real estate, equipment, vehicles, etc.
5. If something goes wrong, the financial penalties can get pretty stiff
This is where not just the penalty fees can kill you, but also the ever-increasing interest rates lenders will charge when you default on a payment or two. Worse, they can suspend your credit at any time, meaning you get no access to the funds and are still on the hook for the outstanding funds.
In circumstances where this happens once or twice, business owners are best advised to have an honest and transparent relationship with their lenders. This way, you can make payment arrangements with them and not damage your relationship with them, or do harm to your overall credit score.
Is a BLoC Right for You?
As you’ve learned, there are a variety of factors to consider including comparing interest rates and fees with other options like personal loans and small business loans, and credit cards.
Then you have to take into account what the money is being used for, your company’s current financial health, and whether you can make your payments on time.
If you are worried about getting your loan proposal approved, you may be interested in the fact that some lenders use multiple data points from various platforms to help you, regardless of your company sizes and growth stage, in securing the BloC.
Always consider all the pros and cons before settling on a deal with any lender. And, it never hurts to get your business accountant on board with reading the fine print contract details before signing away company assets to secure a BloC.
Good luck with your endeavor in deciding whether a business line of credit is right for your business needs or not.