BusinessCash is funding during the COVID-19 crisis.

Entering into a business line of credit, particularly for the first time, can be time-consuming. However, once a line is up and running, the business starts to develop and earn a credit profile of its own. Often the terms, conditions, and restrictions imposed by the line of credit begin to be seen, in time, as important disciplines. Even a journey of a thousand miles begins with a single step. Corporate sharks like Proctor & Gamble, IBM, and GM all started a business line of credit at some point.

Business Line of Credit - Pros/Cons and Alternatives

Pros & Cons of Business Line of Credit

What is Business Lines of Credit?

Business lines of credit generally share these characteristics:

  • Structured as lines of credit in the name of the company. It is possible to repay and reborrow funds up to a specific prescribed credit limit. Only the funds employed will get an interest charge. There are no set repayment requirements, unlike a term loan where a lump sum is advanced at the outset, and then repaid based on an established schedule
  • Pricing is a floating rate, tied to an index, e.g., Prime Rate. The rates can vary from near Prime to Prime + 3-5% per annum depending on the overall risk profile of the borrower, plus “one time” set up fees
  • You may use this for any general corporate purpose – Payroll, Paying Vendors, Taxes, Rent, other expenses

What are The Benefits of a Business Line of Credit?

  • Designed to provide the necessary working capital
  • Flexibility to pay expenses, and cover other general purposes
  • Scalable to help manage cash flow, seasonal needs, unique opportunities
  • Lenders begin to adjudicate credit decisions based on the financial strength of the company, not just the owner
  • Ease of bookkeeping in reconciling personal vs. business expenses

The downside of a Small Business Line Of Credit:

  • Choosing the “right” lender is critical. The “wrong” lender, even one with an attractive product offering, can ultimately cause more difficulties
  • Can be time-consuming and challenging to put in place
  • Can be challenging to administer

Why Do You Need A Commercial Line of Credit?

A small business line of credit is governed by specific ongoing requirements, such as:

  • Limitations on taking on additional debt
  • Restrictions on dividend payments or other capital leaving the business
  • Limitations on owners’ compensation
  • A prerequisite for the company to provide monthly or quarterly financial statements, possibly with additional miscellaneous financial reporting
  • Annual update of the owner’s financial statement

How a Small Business Line of Credit Works?

  • In most cases, the lender files a first lien on all the assets of the business. Exceptions are made for leased equipment (such as photocopiers and other office equipment), heavy equipment used in manufacturing which may already be financed by a vendor or specialty equipment lender, and other assets such as real estate. In these cases, the business line lender normally takes a “second” security interest behind the other lenders. It is a common practice and taken by itself, does not disrupt any existing lease or term lending arrangement.
  • It requires the business owner to guarantee the entire debt personally. Meaning, in the event of a liquidation or cancellation of the line, the owner will be required to come up with personal funds to make good on any remaining responsibility. In some cases where the business itself is judged to be a high-risk candidate, the lender may require a “collateralized guarantee” from the owner requiring a specific pledge of outside asset support (securities, property, etc.)
  • Lines are typically available on a “demand” basis; meaning the line may be subject to modification at any time. Business lines of credit are administered under a form of loan and security agreement which sets out the general terms of the facility, along with the lender’s remedies in the event of a default. Generally speaking, so long as the business remains in compliance with the terms and conditions of the business line, financial institutions rarely cancel outstanding lines of credit

How Can My Business Qualify For a Business Lines of Credit?

A first-time applicant can expect a rigorous and sometimes a lengthy process. This would depend on the lender.
Expect to furnish the following documents:

  • Last three years financial statements of the business (P/L, Balance Sheet, and Cashflow statement)
  • Interim financials year to date for the current year, along with the same period from last fiscal year (for comparative purposes)
  • Copies of bank statements
  • Business tax returns for the prior three years
  • Personal identification –driver’s license, passport, citizenship status
  • Your financial statement
  • Personal tax returns for the previous three years
  • Bio including details of prior business history and education
  • Authorization to run a personal credit check, and a background check

How to Reach/Adjudicate Credit Decision?

Institutions differ regarding the process. However, the design of most business lines of credit are based on an assessment of the following criteria:

  • The amount of time in business. A company that’s around 20 years has most likely dealt with more success and adversity than a company in the industry for three years. History is arguably a proxy for future performance. The longer the track record, the easier the access to credit.
  • The strength of business financials. Most businesses get the grant for a line of credit on the strength of the balance sheet and the quality of the working capital assets. Are the accounts receivable of good quality? Do the client’s pay as agreed? Are there any disputed invoices, or “short pays” from clients? How many days of sales remain uncollected? Does the inventory turn sufficiently often?
  • Collateral. Does the business have pieces of unencumbered assets that can be taken as backstop collateral, or is the business “fully lent”?
  • Personal credit score. Another proxy for how your business will meet its obligations is how you have met yours
  • The strength of a personal financial statement and evidence of worth outside the company.

What Are Other Alternatives to a Business Line of Credit?

There are other options and easier ways to finance a small business which also deserves consideration, including invoice factoring and purchase order finance. These methods are straightforward to put in place, more comfortable to administer, and can provide a range of flexibility suitable to the needs of most growing companies, even start-ups.

Other alternatives, such as “merchant cash advances,” are also natural to establish, but deserve special mention and added caution because of their relatively high notional cost, and difficulty in unwinding.

Aside from traditional lines of credit discussed above, there are several alternative sources of financing for a business that is easier to arrange, more straightforward to administer, and equally accepted. Arguably more flexible, they may also be suitable for a larger universe of potential business users.

Invoice Factoring

Under Invoice Financing arrangement, a business sells its unpaid accounts receivable to a lender for immediate cash at a discount to face value. Since it’s a sale and not a loan, invoice discounting agreements can be consummated in a matter of days with a minimum of paperwork. Unlike business lines of credit, start-up companies, and businesses where the owner has bad, or no credit history qualify for Invoice Factoring.

The cost is higher than a business line of credit. Typically 1-2% per month on uncollected receivable. If there is a sufficiently sizeable gross margin embedded in the product being sold, then the acceleration of cash flow and ease of doing business make this a highly attractive technique. Small and large companies alike broadly recognize and use invoice discounting.

Purchase Order Financing

Under Purchase Order Funding, a lender will help a borrower pay for supplies and materials necessary to fill an order it has received from a creditworthy buyer. The lender receives the payment directly by the buyer of the end product. The credit decision rests on the strength of the buyer, so start-up companies, first-time borrowers, and business owners with poor personal credit all potentially qualify.

Costs here are understandably higher than Invoice Funding.

Merchant Cash Advance (MCA)

MCA is a technique where “lenders” provide a lump sum to a business. They receive repayments daily out of credit card or debit card receipts. Payments are directly from the credit card processing company to the lender. Technically the structure is not a loan but rather a sale of future credit and debit card payments. It has allowed Merchant Cash Advance companies to operate in a largely unregulated market, charging much higher rates of interest. A possible short-term solution for some companies. You should consider it cautiously.

Caveat Emptor

“Buyer beware.” An overarching consideration in entering into a business loan or funding of any kind, is not just “what am I doing, but with whom?” Service after the sale is no less critical in business financing than in any other commercial interaction. Understanding how your lender or financing source might behave and treat you –in good times, and bad—is essential. Developing a sound business relationship with a – good lender can be a rewarding experience, both professionally and personally. Just as a prospective lender takes the time to review your background and experience, you take the time to solicit and review references on them. A lender’s product offering is essential. Customer service and a business-like approach to setbacks and opportunities are critical.

Start Today!

Are you wondering if a business line of credit is right for your company? Call us today, and we can help begin today.

We have over 20 years of experience and 99% customer satisfaction rating. We will take the time to listen and understand your challenges and opportunities. Moreover, we will suggest the best alternative.

Why talk to us? Because we’re going the same way you are – forward.

Ready to solve your cash flow issues? Call (888) 400-5930 or use the fast, safe & secure online funding application.

Back to Top