When running a small business, entrepreneurs are constantly weighing options, especially when applying for business credit. These include, but are certainly not limited to:
- Will I qualify for financing? If not, what can I do to improve my chances of an approval?
- Is the amount I’m approved for sufficient to achieve my goals?
- Will the structure of my financing (amount, term, pricing) result in manageable payments?
One question that I have been hearing more frequently, ever since Dealstruck released its line of credit product, is “should I get a term loan or line of credit and why?”
Term Loan
In its most basic form, a term loan is a lump sum of cash paid back in fixed, equal installments (usually monthly) typically at a fixed rate. This is how Dealstruck’s term loan works.
Fixed Assets: Most people are familiar with term financing because they have taken term loans to finance the purchase of a fixed asset with a long operating life: i.e. a home, car, or college education. These are assets with a long, useful life, and generally involve a one-time expenditure. This rule of thumb generally holds true for businesses as well.
If you need to invest in a new fixed asset for your business, such as property, equipment, or even acquiring a part or whole of another company, term financing is almost always the way to go.
Recently, Dealstruck provided a $250,000 term loan for a construction business looking to purchase a sophisticated marble and granite saw. This saw is capable of cutting 900 square feet per hour, more than doubling its current capacity of 400 square feet per hour and allowing the company to greatly increase its sales volume.
Leasehold Improvements and Software: Similarly, investments such as leasehold improvements and software, while less obviously physical or tangible than a granite saw machine, are often great uses for a term loan, because you can expect to get value from those assets for a long time.
Having a predictable and manageable payment on a term loan in order to invest in assets with a long operating life is key to containing your overall financing costs and keeping cash flow as healthy as possible.
Line of Credit
A revolving line of credit, on the other hand, is ideal for meeting short-term operating expenses. For small business owners, this generally takes the form of paying vendors for inventory, supplies, payroll, and other recurring obligations.
To compare it to another everyday example, you wouldn’t want to finance the purchase of your groceries and gas with a term loan—incurring interest expense long after the food and gas have been used—when a revolving line of credit is just a credit card swipe away. Unfortunately, millions of Americans are paying interest for long-ago consumed gallons of milk and gas.
Short Term Needs: Used responsibly, however, a revolving line of credit is a fantastic way to meet short-term needs, maintain liquidity, and keep financing costs low. Ideally, the business owner only draws what is needed on the line to meet operating expenses and then pays down the line as operating cash flow improves, minimizing the time the outstanding balance accrues interest.
Growth Capital: A line of credit can also be a great source of growth/expansion capital. In order to land new accounts and expand markets, small businesses often have to provide goods and services on credit to their customers—meaning the business is not paid immediately upon delivery of the good or rendering of the service.
Recently, a client of ours landed several new accounts for his green energy and weatherization servicing business. These accounts were large development firms and utilities. The lifetime value of these accounts is huge, and they are propelling his business to a new level, but as is often the case, the terms of the agreement called for payments to be made up to 45 days after our client performs his services.
Without income for up to 45 days and ongoing expenses such as payroll and materials, this customer would’ve been starved for cash, when his company was growing at its fastest pace ever. We set him up with a $100,000 DealstruckCrowdLine line of credit for him to draw upon to provide him with the operating capital he needs to continue growing his company.
Conclusion
Different needs and opportunities call for different kinds of financing for a small business. Dealstruck makes it our goal to fit our clients with the best possible financing arrangement in order to maximize your chances for success!