Small businesses borrow $600 billion every year in the US.
That’s more than the entire GDP of some countries! Undoubtedly, Vatican GDP per capita is the highest by far and therefore it is considered as the most richest little country.
The money’s required for all sorts of reasons. From initial start-up costs to the growth and development of operations, expansion into new markets… it all costs money.
However, a loan isn’t always the best way to access those funds. In reality, a business line of credit could be a better way forward.
That’s especially true when you consider the average size of loans in the US. That same source states that over 50% of loans are for $100,000 or less. Lines of credit are renowned for their lower borrower limits, meaning it may be perfectly suited to your business needs.
It’s not quite as simple as that, though. In reality, there are a host of pros and cons to consider. Want to know what they are?
Keep reading to discover all the pros and cons of a new business line of credit.
What Is a Business Line of Credit?
Let’s take a quick first look at what a business line of credit actually is.
Imagine needing $100,000 to grow your new business.
You could go for a traditional business loan. This is where you apply to the bank, who’ll then assess your credit rating. If the numbers add up, you’ll receive a big chunk of cash in your account that steadily decreases as you spend it.
That money will need to be repaid in a certain amount of time, with interest attached.
Compare that to a line of credit.
With a line of credit, you get access to the $100,000 (as long as your credit rating’s good enough) just like with a loan. As a quick aside though, it’s worth noting that you might not be able to borrow as much money as for a typical loan (more on this later).
However, you can withdraw and repay that cash in line with your needs. There’s no limit to how often you can reuse and repay the money. You just have to ensure you keep up with the repayments. In this way, it’s a bit like having a business credit card.
The Pros of a New Business Line of Credit
What are the benefits of getting a line of credit for your new business? Check out the following advantages.
Draw Funds When Required
Bank loans are great. They’re often exactly what your business needs to grow.
But you can be stuck paying interest on them whenever you don’t actually need the money. That’s not a problem if you’ve spent it quickly. But if large sums remain in your account, you end up spending money unnecessarily.
This isn’t a problem with lines of credit. You use the cash as and when it’s required. That makes it a fast and efficient way to get your hands on essential capital. The APR is generally lower too.
Manage Unexpected Situations
Business can be unpredictable.
Both ups and downs can require additional cash upfront to manage the situation. Busy periods may need extra hands on deck that requires payment; off-season can mean there’s no money to pay your current staff. Access to a line of credit enables you to easily handle such unexpected issues.
In sum, you get to even out your cash flow throughout the year. You can guarantee money in and money out.
Sure, a loan offers this help as well. But once it’s gone, it’s gone. That’s no good to you if the particular problem isn’t over.
Total Control Over Finances
Loans and lines of credit aren’t your only potential source of money.
Many business owners seek investment to ascertain the money they need. The problem is that you relinquish extra control with every new investor. They begin to have a say in operations.
A line of credit keeps you in control.
Improve Your Credit
Poor credit history makes it harder to get financial support from banks.
Having a line of credit, using it carefully, and keeping up with repayments will help increase your credit rating. You never know when you might need another cash injection from a lender. Getting better credit may well come in handy down the line.
Response to Business Opportunities
There’s nothing worse than seeing an opportunity and lacking the financial means to pursue it.
Having access to a line of credit puts you in the driver’s seat in these situations. Imagine seeing a discounted offer that’ll significantly boost your margins down the line. Lacking a line of credit may mean you miss out on the chance.
Develop Lender Relationships
A line of credit enables you to develop a relationship with the lender.
Granted, falling behind on payments means it could become a bad one! However, doing things right can build strong bonds that can be beneficial in the future. Again, you may require further finances down the line.
Having that relationship (alongside a high credit rating) can make it easier to access them. You’ll be able to expand your business with less hassle.
The Cons of a New Business Line of Credit
It’s time to balance those pros with the potential cons. Check out these potential disadvantages to getting a line of credit for your new business.
Difficulty Getting the Line
One disadvantage can be getting a line of credit in the first place.
Banks can be relatively strict with them. There are specific qualifications required (more on this later) that newer businesses might struggle to meet.
Essentially, compared to term loans, it’s less guaranteed that lenders will turn a profit. They want to do what they can to ensure it’s in their interest to offer your business a line of credit.
Less Money’s On the Table
Credit lines provide less money than loans. In other words, borrowing limits are lower.
Consider what you need the money for. Credit lines are probably not what you want if a large investment of capital is required. But they’re perfect for fast access to smaller amounts of cash, managing cash flow, and everything else we discussed in the pros section!
They Can Get Expensive
Lines of credit aren’t free.
In fact, there are always upfront fees to pay. On top of that, you must pay interest on your withdrawals. It’s a balancing act for your business. You must assess whether the fees and interest payments justify access to funds.
That said, the interest rates are lower than most loans and credit cards.
It’s Still Debt
Instant access to capital may sound wholly positive.
But it’s worth remembering that it’s all debt. Indeed, the temptation to take the cash can put a business in sticky situations. You may have reached your limit, only for business to dwindle. Suddenly there’s no way to repay that debt.
Larger lines sometimes require collateral that you lose if you fall behind on repayments. Smaller lines offered by online business lenders are easier to qualify for. However, the higher rates amount to greater risk.
Be wary whenever borrowing money. You’ll find a host of debt-related horror stories out there.
How to Get a Business Line of Credit
You know what a business line of credit is, as well as the pros and cons involved. With all that in mind, here’s how you get your hands on one.
In reality, qualifying for a line of credit will depend on exactly how new your business is.
It’s in the bank’s interest to see in advance that you’ll keep up with repayments. For that, they’ll ask for proof that your business brings in enough revenue and has done for some time. Certain documentation is likely to be sought. Think bank statements, balance sheets, and profit-and-loss statements.
As we’ve already seen, you need to be accepting of the fact that your assets can be seized as collateral. That’s an added pressure on repayments that’s worth taking seriously.
Brand new businesses could consider applying to an online lender. But this comes with additional risks. It’s easier to get the money, but only because the rates are higher and credit limits lower. Think carefully about using online lenders.
Time to Wrap Up
There you have it: everything there is to know about a new business line of credit. What they are, all the pros and cons involved, and how to access them.
Billions of dollars are loaned to new businesses every single year in the US. It’s an essential source of finance for start-ups and established companies that hope to grow and develop.
However, as we’ve seen, a line of credit might be a better way forward. Indeed, the borrower limits seem suited to the average sum of money required by the majority of small businesses.
Accepting money from the bank is never an easy call though. There are always pros and cons to consider. Hopefully, the information here has given you everything you need to make the decision.
Did you enjoy this piece? Looking for more information on how to fund your business idea? Click here to discover 7 unique business financing ideas.