How to Get a Business Line of Credit
Business owners need additional funding for a variety of reasons. It may be for store expansion, purchase of equipment, hiring of additional personnel, and many others. That is why most businesses have several options to raise funds. While taking out a business loan is usually the first option, there are other facilities that can be more beneficial to entrepreneurs than the traditional term loan. One such option is a business line of credit.
What is a business line of credit?
A business line of credit is different from a usual, straight-up business loan in a number of ways. But the major difference is that in a line of credit, you are offered a total amount, say $100,000. But as an entrepreneur, you might not need the entire amount outright, so you withdraw only a portion of that, say $50,000. Lenders then will only charge you interest rate on the withdrawn amount, not on the total amount. You can also withdraw any time provided you do not exceed the total approved amount.
There are several benefits of having a line of credit as opposed to a regular business loan. Firstly, as mentioned, you do not have to pay interest rates for the whole amount if you did not actually withdraw or use the whole amount. This allows you to save money and be flexible with your budgeting and spending.
Also, you can apply for a business line of credit even if you do not plan on using it yet with very minimal or no cost to you. This means that if you are a business owner who has a credit line with a bank or lending company, you have a source of funding that you can tap onto in emergency cases, like a sudden drop in sales or an accident at your shop. A business line of credit will provide a cushion against sudden expenses without the high fees typical of business loans.
Requirements for a business line of credit
Like regular business loans, there are a couple of requirements you need to acquire before you are granted a business line of credit. Here are some of them:
Lenders and banks require a legally-registered business for lines of credit. In most cases, your business should already be in operation for at least a year before you can be considered for a line of credit. Most lenders will also require various financial documents to be submitted. Here are the list of some of the business documents that might be needed for your application:
- business registration documents
- tax returns
- accounts receivable
- business bank account numbers
- bank statements
Good financial status
As with other kinds of business loans, having a good cash flow is critical if you want to increase your chances of being approved of a line of credit. A positive revenue in the past few months prior to the application of the line of credit is a good indicator of your ability to pay, and thus, banks and lending companies will think of your application as less risky than others.
Good credit score
A good credit score to go along with good financial standing is one of the best proofs that you can pay loans, and consequently, gives you the best chance of having your application for a line of credit approved. As mentioned, banks and lending companies are taking on risk when they consider an application, and a good credit score lowers that risk for them, as it tells them that you have a good history of paying your debts. Although the credit line you are applying for is for your business and not for you as an individual, a good credit score is a good additional document you can prepare.
Steps in applying for a business line of credit
Now that you have an idea of the things you have to prepare for your application, it is time to go out and actually get one. Here are some of the steps that you can take to ensure you have the biggest chance of getting approved:
Research as much as you can about banks and lending companies, and what they offer in terms of business line of credit. Carefully study their fees, interest rates, other payables, and their application process.
Select your lending institution
There are a couple of options in terms of which type of company you can apply a line of credit for depending on the amount and terms you can get. Here are some of them:
Banks – Banks have been the traditional source of lines of credit. If you are a business owner, chances are, you already have a bank where your business’ funds are handed too. Take advantage of your past relationship with your bank to get a good term on your line of credit, as they would have an idea of your financial capabilities, habits, and history.
Depending on the bank, they can offer secure or unsecured lines of credit. Applying for an unsecured line of credit means there will be risk for you, since you would not have to pledge anything as collateral in order to be approved. The downside is that they usually come with higher interest rates. As for the secured lines of credit, they usually have lower interest rates and longer payment terms, as it should, given that you are pledging to them a kind of property (e.g. house, car) that they can sequester should you be late on your payments or default on your account.
Online lending companies – online lending companies have seen exponential growth in popularity in the last couple of years. This is because they usually require less documents than traditional banks and lending institutions, and process loan applications much faster as well. Online lending companies also place more emphasis on the current financial standing of clients, which enables some businesses to be considered even with bad credit ratings and gives you access to start up business loans with bad credit. This rather easier application process is balanced out by their higher interest rates and lower offers. By being more forgiving and accommodating of clients’ loan history, online lending companies are also taking on more risk, which explains why they charge more than banks.
Business credit cards – while might seem common to individuals, some business owners are not aware that you can actually get the best small business credit cards for your business. In essence, a credit card is a form of line of credit, with the same principle of having to only pay for what you use being applied. The difference is with regular lines of credit, you can easily obtain cash from your lender. While some credit cards do offer cash advances, they often impose limits on cash transactions and instead, wants you to use your credit card for cashless purchases. Also, credit cards tend to have lower limits than regular lines of credit. Still, this is a proven way to augment your financial capacity and certainly must be considered by every business owner.
Companies with invoice financing – it is very typical of businesses to have receivables from a variety of entities – clients, suppliers, and other groups or individuals. Some businesses go under not because they do not have sales or cash, but because clients or suppliers that owe them do not pay on time. In these situations, you can look at companies that offer invoice financing as a form of business line of credit. Having invoice financing means you can borrow cash equivalent to your invoice or receivable, enabling you to use your funds even though you have not been paid yet by your client or supplier. This is an effective and practical means to obtain a line of credit since in essence, you are expecting to receive cash, you are just getting it in advance. There are many factoring companies that offer this service.
After choosing your preferred type of company, it is now just a matter of following their application process and making sure to provide all the necessary requirements and documents. As mentioned before, any document that can convince them that you have enough resources and income sources to pay off the line of credit will only increase the chances of your application being approved. However, there are some things you do need to avoid when applying for a business line of credit. Here are some of them:
Providing banks or lending companies with inaccurate or incomplete documents greatly reduces the chances of getting your application for line of credit approved. This also lengthens the application process, as they would have to ask for explanation for any discrepancy in the figures or information in the documents. In some cases, clients can even face legal sanctions and lawsuits if they deliberately provide false or inaccurate documents and data just so to increase the chance of getting their application approved. Give as much documents as you can but make sure that they all contain accurate data and information.
Rushing your application
Rushing your application for a business line of credit will not end well for you. Aside from the documents that you will probably forget to submit, you will also gloss over the details of the terms that you will be offered, which could prove very costly in the event something goes wrong with your account. Take your time to study all your documents as well as the fine print of your application and contract so that you will be able to protect yourself from legal loopholes or abusive terms. You are already taking on risk by applying for a business line of credit, so do not add on to this risk by haphazardly going through the application process.
Having little to no plan on how to use funds
Applying for a business line of credit without any prior plans on how your are going to use it for your business can be a very costly move on your part. Building a reputation as a good bank or lending client takes time, and if you are not sure how you are going to use the line of credit, there is a big possibility that you will misuse and misallocate it, and therefore, you are putting your credit history at risk. It will also affect the line of credit that you can receive, as it could be less than or a lot more than what your business actually needs. Either way, it will only cause you to pay more fees and interests that you could have otherwise avoided with a sound financial plan. Calculate how much you really need and then just add a little bit more so you would have a buffer in the event that they approve a lower business line of credit. But whatever you do, do not apply for a business line of credit arbitrarily just because you think having more cash is never a bad thing.
Being arrogant and discourteous
This seems simple, but some business owners feel entitled to bigger lines of credit just because they are a bank’s or lending company’s client. As explained above, approval of an application for a business line of credit depends on a lot of factors, even personal relationships, and that is why you should be courteous whenever you approach lending institutions. The best approach is to forge pleasant and beneficial relationships so that even in the instance that you may have less than the required documents or information, you would still have a chance of acquiring a business line of credit by virtue of the relationships you have cultivated with your lender. Aim to make your bank or lending company your business partner, so that whenever you need financial assistance, they would be more inclined to help you out.
In the end, getting a business line of credit should not be as scary or as daunting as some business owners think. It all it takes is careful planning and research, and a sound financial plan. Spend time trying to find the best offers, and do not readily settle for the first one you see or the most popular lending company. Done right, business lines of credit can be a very powerful tool at your disposal to grow your company and reach another level of success for your business.
William Anderson has been working with small business owners for the past 10 years. He got his start at an investment bank, but felt that he was too detached from where real people were making decisions that affected local economies. As a result, he took his experience and his MBA degree to work helping local small businesses.
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