If you could use some extra cash flow for your business, then a business line of credit could be the flexible funding option you need. Many business owners turn to business lines of credit for their versatility, convenience, and quick access to funds. Plus, with responsible and timely payments, a business line of credit can help to establish or build a business’s credit history.
As with any type of borrowing, a business line of credit is far from free money—and businesses must meet certain requirements to borrow. In the sections below, we’ll go into detail about how lines of credit for small business work, how they differ from traditional business loans, and the common requirements to be approved for one.
What is a business line of credit?
Specifically, a business line of credit refers to access to a pool of funds that businesses can draw upon on an as-needed basis. From there, interest is paid only on the amount that has been borrowed—and funds are replenished (and thus available for future borrowing) as they are paid back.
Compared to a lump-sum or one-time loan, a business line of credit is revolving in nature—similar to the funds on a credit card.
How does a business line of credit work?
When a business is approved for a business line of credit, they are typically approved with a set borrowing limit. From there, businesses can borrow as much or as little as needed up to that limit, paying interest only on the amount that they have borrowed at any given time.
If the limit on a business line of credit is $10,000, for example, a business may choose to borrow $3,000 and only pay interest on that amount. Meanwhile, the business has the ability to borrow up to an additional $7,000 at any time if needed. As the initial $3,000 balance is paid down, it also becomes available for the business to borrow again.
Interest rates on a business line of credit are often variable, but the rate often depends on personal and business credit scores, whether the loan is secured or unsecured, and other risk factors.
Common uses for a small business line of credit
There are many potential ways in which a small business line of credit may be used, such as:
- To fill cash flow gaps, especially for seasonal businesses.
- To buy inventory or supplies in bulk without affecting cash reserves.
- To cover unexpected expenses, such as replacement of a company vehicle or machinery repair.
- To fund important growth and expansion opportunities.
On the other hand, there are some situations where it may be better to seek alternative funding options. Consider, for example, that a business line of credit loan cannot be used for personal reasons—and doing so could lead to legal issues down the road.
Likewise, larger and longer-term investments are generally best suited for a term business loan—which may allow for more favorable interest rates and repayment terms.
Business line of credit vs. loan
If you’re considering a business line of credit, it’s also important to consider the differences between this funding option and a more traditional business loan. By knowing the key differences between each, you may be prepared to make a better informed decision.
Compared to a business line of credit, a business loan is a one-time, lump sum payment. Typically, paying back a small business loan means making fixed monthly payments over a specific term. Typically, these types of loans are best for businesses that need to make a large, one-time investment or purchase because they often come with lower rates that make for more predictable repayment and budgeting.
A business line of credit, on the other hand, is not a one-time payment—but a revolving pool of funds that businesses can draw on at any time. Compared to a business loan, interest on a business line of credit tends to be higher and may also be variable in nature. However, because of the flexibility and convenience of this type of funding, many businesses will rely on lines of credit for everyday cash flow management and unexpected expenses.
Ultimately, neither a business loan nor a business line of credit is an inherently better option. It simply depends on what you plan on using it for and your business’s unique needs.
Business line of credit requirements
When it comes to requirements to take out a business line of credit, it’s important to understand that requirements can vary from one lender to the next. However, all lenders take into account some important factors when determining eligibility/qualification for a business line of credit, including:
- Personal and business credit scores – This includes not just the business’s credit history, but the credit history of the owner as well. Some lenders may require a specific credit score.
- Revenue and cash flow – The amount of steady income a business receives annually, including how much cash the business has on-hand at any given time.
- Time in business – More established businesses may have an easier time qualifying for a business line of credit than newer businesses—and newer businesses may be charged higher interest rates.
- Industry risk – Businesses in higher-risk industries may have a harder time getting approved, and approval may come with higher interest as well.
Compared to a term business loan, a business line of credit often has slightly stricter qualification requirements—but for businesses that do qualify, a business line of credit can be an excellent funding option in certain situations.
Types of business line of credit lenders
So, who offers business lines of credit? Typically, you can apply for this type of financing through a traditional bank or online credit lender, keeping in mind that terms and access can vary greatly across lender types.
Bank business lines of credit
Traditional banks may offer business lines of credit, often with more competitive rates and higher borrowing limits. However, they may also have stricter and more competitive eligibility requirements, so businesses with strong financials or a more established background may have an easier time getting approved.
Online business line of credit lenders
Today, there are also many online lenders that offer business lines of credit. The biggest appeal of this option is that online lenders are often much faster at processing applications and making funds available—making this an appealing option for businesses that need quick approval and disbursement of funds.
Compared to traditional bank lines of credit, however, terms may be shorter and come with higher rates, which is why taking the time to understand your repayment terms before you commit is so important.
Examples of business line of credit from major banks
Many well-known banks offer business lines of credit, although availability, terms, and approval depend on business qualifications and other factors.
American Express business line of credit
American Express offers online business lines of credit ranging anywhere from $2,000 to $250,000, with instant deposits into an Amex Business Checking account. Repayment terms range from six to 24 months, but approval is not guaranteed.
Chase business line of credit
Looking for a more traditional bank option? Chase offers business lines of credit ranging from $10,000 to $500,000 for existing Chase for Business customers, with funds available for five years. Availability can vary greatly based on business profile, and strict eligibility requirements must be met.
Bank of America business line of credit
Bank of America offers both secured and unsecured business lines of credit, with terms varying based on business size and history. Borrowing amounts start at $25,000, with annual renewal and a minimum of two years in business required.
Preparing your business before applying for a line of credit
If you’re thinking about applying for a business line of credit, there are a few simple steps you can take before you submit your application to potentially improve your chances of approval. This includes:
- Ensuring legal formation of your business.
- Choosing the right legal structure for your business (an LLC is often the best option when you need personal liability protection).
- Having an Employer Identification Number (EIN) assigned by the IRS, as well as an active business bank account.
- Making sure that your financial records are well organized and that any requested documentation will be easy to access.
Although taking the right steps to prepare your business for a line of credit application may improve your chances of approval, it’s important to understand that this setup does not guarantee approval.
When a business line of credit may not be the right fit
A business line of credit can be a practical funding option in many common small business scenarios, but it may not be the best fit for situations where your business needs to make a large, lump sum purchase or investment. In these instances, it may be better to explore a small business loan or other funding options. Ultimately, making responsible borrowing choices as a business owner is all about matching your business needs to the right funding type.
Conclusion
Offering flexibility, convenience, and structure, a business line of credit can be an excellent choice for businesses across all industries. The key, of course, is to fully understand your terms and repayment before you sign off. With all this in mind, you’ll be able to make more informed borrowing decisions as you start a business and plan for ongoing growth.
Looking for more guidance? Tailor Brands is here to help with many of your business formation, compliance, and branding/marketing needs. Get in touch to learn more about what our team can do for you!