A business line of credit is a promising financing option for entrepreneurs looking for a quick capital injection. But it isn’t exactly like your average term loan.
So, how does a business line of credit work?
It’s similar to a credit card in that business owners can access funds from a revolving line of credit — as and when they see fit. However, the interest rates are lower than those of credit cards and are charged only on the amount drawn, along with a small fee.
Because of its flexible repayment terms, relaxed eligibility criteria, and competitive interest rates, a business line of credit has helped thousands of organizations replenish inventory, expand offerings, upgrade equipment, and fill cash flow gaps.
Does this sound like something your operation needs?
Follow these five steps the next time you’re applying for a small business loan.
Step 1: Evaluate Your Financing Needs
A business line of credit is not a one-size-fits-all financing option. It can be especially advantageous when used right or expensive if the terms are not properly understood. For this reason, it’s crucial for businesses to analyze their requirements before applying for a line of credit. Are you, for example, looking to secure financing to make up cash flow shortages, buy new property, or cover payroll?
Fortunately, there are few restrictions on how you can spend a line of credit. But with that said, depending on the provider and your financial history, the credit may not be enough to cover major purchases or real estate. Instead, an operating line of credit, when used responsibly, is best used for purchasing inventory, enhancing marketing budgets, and scaling operations over short terms.
The second consideration is how much credit you need. While some online lenders offer up to $500,000 in credit, it’s worth analyzing your exact business line of credit requirements, to keep costs low. Some ways to assess your needs include:
- Analyze cash flow statements to learn how much business you’re losing to pending invoices, seasonal slowdowns, and emergency expenses.
- Consider fixed and variable expenses to forecast future projections accurately.
- Use a business loan calculator to consider the impact of interest rates and repayment terms to identify how much credit you can afford to draw.
Step 2: Analyze Factors That Impact Credit Lines
Qualifying for a line of credit may be easier than a term loan, but lenders still evaluate a host of criteria when deciding terms. Businesses with good credit scores, for example, are usually able to secure more favorable rates, especially from banks and credit unions.
However, many lenders relax their requirements for businesses with poor credit. To secure a line of credit for a new business, the following factors may play a role.
- Business revenue: Many lenders will require businesses to show a minimum annual revenue to qualify. Some are more flexible than others.
- Financial statements: Lenders may also look into cash flow projections, balance sheets, income statements, and tax returns to assess creditworthiness.
- Vendor payment history: Businesses that make timely payments are more likely to secure favorable terms.
- Business plan: Businesses with comprehensive revenue forecasts, clear strategies for growth, and effectively communicated expansion plans see more success.
Moreover, lenders also consider the type of industry a business operates within when making the decision. They may tighten the reins in case of certain high-risk businesses.
So, to properly leverage business lines of credit, it’s crucial that you conduct a comprehensive financial health check-up. Consider the impact of factors like:
- Current pricing strategies
- Seasonal slowdowns
- Customer payment patterns
- Vendor payment terms
- Tax rates
And more.
Step 3: Research Potential Lenders
Banks were once the only major source of funding. However, the rise of FinTech services has significantly enhanced credit availability and eased requirements. Today, there are multiple types of lenders that offer lines of credit.
- Banks and credit unions: Traditional lenders could offer a line of credit for businesses with competitive interest rates. However, they are usually a better choice for those with solid credit scores, substantial revenue, and significant experience.
- Online lenders: Usually have much more relaxed eligibility criteria, varying interest rates, and faster application and approval times.
Some businesses may also qualify for the Small Business Administration (SBA) line of credit, which offers up to $5 million through one of its approved partners.
There are pros and cons associated with each option. When researching potential lenders, you should carefully compare them based on factors like the maximum credit limit offered, terms of service, requirements, rates, fees, and lender flexibility.
A bank may have stricter criteria as compared to online line of credit providers but may also have more favorable terms. Online lenders, on the other hand, have much faster turnaround times and higher-than-average interest rates. With that said, when used responsibly, online options can be very cost-effective despite fees and factor rates.
Another aspect to consider is whether the credit line is secured or not. A secured line of credit requires businesses to pledge collateral in return for favorable interest rates. This could sometimes be strong collateral, such as real estate, but in most cases, receivables are sufficient to access credit lines.
An unsecured line of credit, on the other hand, may have higher rates to offset the risk of not having any collateral. But, businesses with strong credit scores, clear projections, and experience can secure better terms, regardless.
Step 4: Prepare a Credit Line Application
Once you reach the application phase, most of the hard work is behind you. However, there are still several documents you’ll need to successfully carve out an application.
These include:
- Legal documents, such as business licenses
- Bank statements
- Financial statements, such as profit and loss reports and tax returns.
- Comprehensive business plans
- Collateral documents (if applicable)
- Existing liabilities (if applicable)
- Insurance documents
Certain lenders may require more documentation, or have an easier application and approvals process. But either way, having a strong business plan can help inspire trust.
To draft a compelling application, it’s not only crucial to have all paperwork in order, but also that you know how to present your case effectively.
While there are no set restrictions on how a credit line can be spent, it’s worth clearly outlining your plans to the lender anyway. Break down how much you plan to spend on various categories — buying inventory, investing in marketing, expansion, etc — and emphasize how the credit will contribute to your overall growth.
There are also some common mistakes to avoid when applying for a corporate line of credit. Many businesses, for instance, neglect to read the fine print, or fail to build accurate credit profiles, or even make errors in listing personal or business information. Mistakes like these can have an impact on processing and turnaround times.
Step 5: Apply and Negotiate Terms
A business line of credit application can be delivered in person or submitted online. During a one-on-one meeting, your lender may ask for additional information, such as your social security number, the purpose of your loan, and your annual revenue.
Similarly, to apply online, you will first have to upload relevant documents. Once that’s done, you may be prompted to consult with a financial advisor to discuss the specific terms before your loan is processed. As you’d imagine, doing it online is a lot faster — with credit lines often approved within 24 hours.
Meanwhile, when negotiating terms, consider some of the following questions:
- Are the interest rates fixed or variable?
- The typical draw period for a line of credit can be anywhere between two to five years. Which aligns best with your cash flow reports and financial projections?
- How equipped are you to make timely payments based on the outlined schedule?
- Have you accounted for associated fees — such as the draw fee, late fees, termination fees, among others?
The Bottom Line
Businesses looking for a quick injection of capital have several options at their disposal — with credit lines for small businesses often approved and processed in as little as a day. But to make the most of the financing option, it’s not only crucial to learn how to get a line of credit, but to take a methodical approach to identifying the best terms.
Businesses should properly evaluate their goals, analyze the factors and criteria that influence their application, and research various lenders to ensure that they come away with higher credit amounts and lower interest rates.
For any further assistance, don’t hesitate to reach out to a Greenbox Capital manager, who will work closely with you to build strong applications and secure favorable loans.
Sources
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