If you are a small-business owner, you are probably all too familiar with the concept of debt. In addition to your personal debts, you probably have a small-business loan or two, as well as a business credit card for smaller purchases. You probably have dabbled with some kind of merchant cash advance or receivables financing, and you might still be looking for a source of funding that suits your spending habits.
One funding source that many small-business owners overlook — or never consider at all — is a line of credit. Lines of credit differ from other types of business funding in ways that make them attractively flexible to nearly every small business, from those with cash flow crises to those looking for money to grow. Even those entrepreneurs who struggle to obtain loans can usually find a line of credit appropriate for their needs. Here’s why you should consider becoming more familiar with business lines of credit.
Explaining a Business Line of Credit
Most small-business loans take the form of term loans — or loans for a specific amount that must be repaid following a certain schedule. As you well know, business loans offer amounts between $5,000 and $500,000, and they can take decades of monthly payments to pay off. If you don’t need that much money to keep your business running, you should avoid taking out a loan that could cripple your business finances for the foreseeable future.
On the other end of the funding spectrum are business credit cards. Like personal credit cards, business cards only accrue interest on the amounts of balance used, making them more flexible and affordable financing options. What’s more, you can earn rewards for spending with your business card, including discounts on office supplies and other business necessities. Unfortunately, business credit cards, unlike personal credit cards, aren’t covered by consumer protections, so credit companies can make unexpected changes to your interest rate or fees — a notable downside to credit cards’ flexibility.
A line of credit is somewhere in the middle, between term loans and credit cards. Like loans, lines of credit offer substantial sums that are often devoted to significant business processes, like remodeling and construction, purchasing inventory or other assets, launching a new marketing campaign, or covering unexpected expenses during times of uncertain cash flow. Yet, like credit cards, you need only pay interest on the amount of balance you use, which prevents your payments from getting out of hand. What’s more, lines of credit can be revolving, which means you can have a convenient source of capital at your fingertips whenever you need it.
Types of Lines of Credit
The most important distinction to make between lines of credit is that of secured and unsecured lines. The same terminology is used in loans and credit cards, so you are likely familiar with the concept: A secured line is backed by an asset, such as a home, and thus garners a lower interest rate whereas an unsecured line lacks any collateral and typically requires impeccable credit to secure.
Additionally, there are distinctions between open and closed lines of credit. Open lines revolve, meaning they are essentially always available to you during a certain period. Typically, lenders will increase your credit limit if you prove reliable at making timely payments, and in theory, your open line could remain open in perpetuity. Working capital or payroll lines are usually open because small businesses frequently need access to funds to cover revolving costs.
Conversely, closed lines provide a single fixed sum of money for a specific purpose, and the line disappears entirely at the end of the established term. Usually, lenders expect full repayment within a year after the closure of the line. A classic closed line of credit is an asset purchase line, which you might obtain for the one-time purchase of expensive equipment.
One final type of line of credit — and one that not many business owners have access to — is a guidance line. Also called an uncommitted line or an unadvised line, guidance lines are approved by banks but not dispersed until you truly need it. Often, guidance lines offer higher balances, upwards of $1 million, and provide businesses the opportunity to make investments quickly without worrying about renewing their line of credit.