How to pick the right business line of credit for your needs

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April 11, 2017 | Updated September 19, 2017


Key Points

Compare types of business lines of credit

  • Secured business lines of credit are typically easier to obtain than unsecured lines.
  • Traditional unsecured lines can be challenging to obtain.
  • Nontraditional unsecured lines are faster and easier to obtain.
  • Lenders evaluate credit scores, time in business, financial solvency and collateral.

Maintaining a healthy capital flow is crucial to sustaining business operations during lean periods. Business lines of credit are revolving loan facilities that provide businesses with access to short-term working capital and offer flexibility and interest rate benefits that are not available through term loans.

With the variety of business lines of credit available on the market, selecting the option that best suits a company’s risk profile and objectives is imperative in making the most of this product.

Business lines of credit fall under two broad categories — secured and unsecured — both of which include distinct credit options.

Secured lines

Similar to an individual home equity line of credit, a secured business line of credit requires assets to be pledged as collateral in the event the company defaults on its loan obligations. For businesses, the types of assets used to secure a line of credit typically fall into two broad categories: short-term assets and capital assets.

Business lines of credit secured by capital assets, such as real estate and equipment, put a heavier risk burden on the borrower, as a business could lose everything in the event that it cannot repay its debt. A line of credit secured by short-term assets, such as invoices and inventory, offers a more balanced distribution of risk between the business — which can retain its essential capital assets in case of foreclosure — and the lender, which can liquidate the short-term assets to cover the business’ debts. Securing a business line of credit with short-term assets is a more common practice.

Obtaining a secured business line of credit will require ample documentation  that includes verification of time in business, financial and tax reporting, inventory statements and a history of reliable payment. These factors will all influence interest rates. Lenders also may charge upfront fees for due-diligence work. Secured business lines of credit are typically easier to obtain than unsecured options and offer lower interest rates.

Traditional unsecured lines

While unsecured business lines of credit do not require any collateral, the increased risk for the lender is reflected in qualification requirements and interest rates. Within unsecured business lines of credit are traditional and nontraditional products.

Traditional unsecured business lines of credit require thorough demonstration of creditworthiness and business security to determine eligibility and interest rates. Documentation required includes business registration and verification of time in business, financial balance sheets, bank-account information and personal and business tax returns — as well as an annual financial review to verify continuing business solvency.

Traditional unsecured lines of credit are the most challenging to obtain and sustain because of myriad documentation requirements. For a business that enjoys robust financials but needs a capital boost during a low period, however, it can be a less onerous option compared to obtaining a secured business line of credit.

Nontraditional unsecured lines

Nontraditional unsecured business lines of credit typically take the form of business credit cards. Little documentation is required and there are no annual financial reviews. With fewer application procedures, it is much easier and faster to obtain a nontraditional unsecured business line of credit compared to a traditional one. Eligibility and interest rates are based on a FICO credit score, with some lenders even offering a zero percent interest rate for an introductory period.

Another benefit to the nontraditional unsecured option is that business credit is built up separately from the owner’s personal credit. One does not affect the other. The business owner, however, remains personally responsible for the outstanding loan balance should the business default and end up in litigation with the lender.

With credit limits ranging from high to unlimited, easy eligibility and a fast approval process, going the nontraditional unsecured route may seem ideal. It is possible, however, to accumulate significant debt with a business credit card if it is not used wisely. Businesses should be realistic about their ability to control spending and meet payment obligations.

Building credit

For new businesses with limited credit history, online lending companies are often willing to extend business lines of credit, albeit at higher interest rates. The U.S. Small Business Administration also offers business lines of credit to small and developing companies through their CAPLines program, which includes four different revolving credit-facility options: contract loan, seasonal line of credit, builders line and working-capital line of credit.

As with a personal line of credit, the ideal business line of credit option depends on a borrower’s financial situation and repayment ability. Business lines of credit should never be used to keep a sinking company afloat, but rather as a calculated financial tool to help sustain capital flows and growth during anticipated seasonal lows, mergers and acquisitions or other unique circumstances.

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