Is a Business Line of Credit A Good Idea?
Business lines of credit can be a useful tool for small businesses, particularly if you’re in growth mode. Just like other financial products, they come with both advantages and disadvantages that need to be weighed for each business.
Whether a line of credit is a good idea for your company will depend on your specific needs and stage of business but here are a few ways to look at the financial tool as you decide whether it could be the right move for you.
How it Works
More like a credit card than a traditional loan, a business line of credit, once approved, is money you can access when you need it.
It functions similarly to a business credit card or personal line of credit, however it is much cheaper for getting cash advances, notes Jared Hecht, cofounder and CEO of Fundera.
“This line of credit can be unsecured up to a certain amount (such as $100,000), which means you won't have to put up collateral, or it can be secured by a personal or business asset,” he writes in a blog for Inc.
Unlike a traditional loan, which provides you with a lump sum of cash to be paid at a fixed or variable interest rate over a certain timeframe, the business line of credit allows you to tap into funds as you need them.
“This gives you control over how much money you take and when you take it,” writes Hecht. Additionally, you are only required to pay interest on the amount you use.
“Having this type of credit in your financial playbook comes with perks that make managing and expanding your business easier,” he says.
With a line of credit, you make regular payments along with interest on the amount borrowed until it is paid off. You can continue to draw money until your credit limit is reached (assuming you remain in good standing).
Eases Cash Flow Issues
Many small businesses are familiar with a situation where income is lagging slightly behind expenses – the cash flow crunch.
“It happens to every business owner, there’s a gap in funds and it looks like things are going to start getting a bit too tight,” says The Realtime Report, a newsletter published by the Washington D.C.-based Cool Blue Media.
A line of credit can ease the pressure in these gaps in your earnings, whether it’s caused by a slow season or an investment that went downhill.
“Seasonal businesses can benefit from a line of credit when the cash influx from peak times isn't quite enough to make it through the leaner months,” writes entrepreneur Brian Smith in a blog for the nonprofit advisory group SCORE. “You can draw from the line when it's slow, then pay it down when the crowds return.”
Can Help With Growth
A line of credit can always help your business have sufficient cash flow at all times – which is crucial to meeting goals, and ultimately growing the company, says Fundera’s Hecht.
“The ability to continually access funds enables greater control over your business's finances, and gives you the freedom to continually make growth-driven decisions,” he writes.
More working capital can free you up to focus on long-term growth efforts, like hiring, relocating, or purchasing a second business,” writes Paige Smith in a blog for Fundbox, a financial tech company based in San Francisco.
With a line of credit, you can also take advantage of opportunities you’d otherwise have to miss due to a lack of capital. It could provide a chance to partner with another business or organization to sponsor a community event, sales promotion or an advertising opportunity.
However, experts advise caution when you activate a line of credit – you need the discipline to use it wisely.
“Not every opportunity is a good one, and if you act on too many at once, you may not leverage any of them as much as you should,” writes Smith in the Fundbox blog. “It can be surprisingly easy to ‘accidentally’ borrow too much against your business line of credit and spend your profits on interest payments.
Credit Building Tool
A line of credit often puts you in direct contact with a decision-maker or customer representative at the financial institution where you were approved. As a result, it gives you the opportunity to build yourself into a known reliable borrower.
“It's a great way to build business credit and build a relationship with a financial institution so that when you need more capital down the line, now you've got this history," says financial advisor Ken Alozie, a mentor with the nonprofit SCORE and a principal at Greenwood Capital Advisors in Washington, D.C.
And that regular, personal contact makes it easier for you to get other loans with the same institution later, writes Brian Smith in a SCORE blog.
“The next time you need a new company vehicle, equipment loan, or to raise the limit on your line of credit, the process will be streamlined, and the terms will likely be better,” he writes.