Pros and Cons of Funding your Business with a Bank Line of Credit
A bank line of credit (LOC) works similarly to both bank loans and credit cards in certain aspects. With an LOC, you are approved by a lender to borrow up to a specific sum of money. Unlike a loan, you do not take the full amount in one lump sum. Instead, like a credit card, you only use what you need when you need it up to the maximum limit and the credit is revolving. You pay interest only on the sum that has been borrowed, not the total sum for which you are approved and there is no specific end date.
This can be a viable funding option for some small businesses. But, like any type of funding, there are pros and cons.
A well-managed LOC impacts a company’s cash flow in a positive way. The amount of cash a company has immediate access to is often one of the most important aspects in assessing overall fiscal health. Especially in the early months when revenue can be unsteady and unpredictable, having access to a line of credit can keep things running smoothly. Additionally, delays in accounts receivables can be mitigated with the use of an LOC.
Once approved, there are very few restrictions for how borrowed funds can be used within your business. An LOC allows you to quickly act on unexpected and time-sensitive opportunities, which are quite common in business.
Building Business Credit
If you use the LOC responsibly and make your monthly payments on time, it will help establish business credit. Just like personal credit, business credit has a significant impact on future finances. Whether vendors will allow you to purchase from them on terms, if you’re approved for future loans, and what your future interest rates will be, will all depend on your business credit.
Even if the business fails, the business line of credit must be paid back if it has a personal guarantee which is common for early stage ventures. In addition, many lines of credit are secured, requiring collateral, typically in the form of hard assets such as real estate or automobiles. Most business owners want to bet on themselves, but risks like these can keep them up at night. Unsecured LOCs are an option as well, but they are much harder to obtain at early stages and carry much higher interest rates.
Like taking on any type of debt, you will pay interest. When considering a line of credit, beyond just the interest rate, there are often upfront fees as well as other charges. It is imperative when considering where to apply for a line of credit that you know what their terms and fees are likely to be.
While the flexibility of an LOC can be appealing, securing a maximum large enough to truly fund your short-term needs can be difficult, especially for a startup with little to no collateral.
If you choose to pursue a line of credit, you will need to persuade a bank that you, personally, are credit worthy and that you have a thorough and lucrative business idea. Especially for new businesses, it can be hard to qualify for an LOC. However, Joorney can help prepare you to meet with the bank with confidence.
We can help you craft a sound, compelling business plan. In addition, our advisory services can give you insights into whether an LOC is the best funding option for your business. If so, we can apply the valuable insights garnered through our connections with several financial institutions to give you the best chance at securing the LOC you desire.