A business line of credit can be a useful source of working capital for a small business. Its important to know the business line of credit pros and cons.
A line of credit is similar to a credit card in some ways. Like a credit card, there is a limit – usually up to $250,000. If you don’t draw on it, you don’t pay any fees.
Credit lines are either revolving or non-revolving. With revolving credit, you can spend up to the credit limit. If you don’t use the credit, it won’t expire or close. If you do draw on the line, you can repay the loan and retain the line.
For example, if you have a $250,000 credit line, you can draw $100,000 and the balance will remain available. If you repay the $100,000, you will still have the $250,000 credit.
A non-revolving line is a lump-sum financing. You get it all at one time. When you pay it off the line closes.
Pros of a business line of credit:
Smooths Out Cash Flow for Seasonal Businesses
If you’re selling toys or candy, for example, most of your sales come during Christmas or Valentine’s Day. You may be short on working capital during the summer, but are certain to make it up when the season changes. Because you can’t use a credit card to pay your employees, a small business line of credit can get you over the hump.
You Only Pay for What You Use
When you receive a credit line, you only pay interest on the amount that you use. Also, depending on the agreement with your lender, you may be able to pay off the balance at any time without a prepayment penalty.
Makes Your Business More Nimble
There may be times when you have a limited window to buy a product or service at a bargain basement price. But you may not have the cash on hand to do it. A business line of credit will allow you to take advantage of an opportunity that will save you money in the long-run.
Builds Business Credit
If you’d like to boost or maintain your credit score, receiving a business line of credit and paying it off responsibly can be a great way to achieve this.
As with any type of business loan, there is a downside.
Cons of a Business Line of Credit:
Extra Charges and Fees
The “pay-as-you-go” format may make it seem like a no-brainer, but fees and extra charges can quickly add up. These additional costs will vary from lender to lender and will depend on the other agreement terms.
It pays to do your homework. Shop around and compare not only interest rates, but fees and terms.
Not Every Business Qualifies
Online business lenders typically have looser qualifications than banks. However, these lenders are also likely to charge higher rates and may have lower credit limits.
You’ll need to supply financial statements, business and personal tax returns, bank account information, business documents, and more.
At a minimum, you’ll need at least six months in business and $25,000 in annual revenue to qualify for a business line of credit from an online lender. Banks may require more.
Potential for Misuse
A business line of credit should only be used as an insurance policy for cash flow shortages. Like a credit card, it can be tempting to misuse it.
If your business has already acquired significant debt, or you simply aren’t confident that you’ll be able to repay your balance, think twice about a line of credit.
Low Borrowing Limits
This isn’t the right type of financing if you are planning on a major expansion or construction project.
Weigh the pros and cons of obtaining a business line of credit carefully. Many experts including Entrepreneur recommend applying for a business line of credit even when you don’t need it. That way, when you do need it, it is already in place and you don’t have to negotiate from a position of weakness.