When your small business is not bringing in the revenue you need to cover all of your business expenses or expand your business, you need to find a new way to bring in some cash. Whether you need to purchase new inventory, cover operating expenses, expand your physical location, or something else, that new capital is crucial to helping you achieve these goals. Fortunately, there is a way that you can get funding for your business without taking out a small business loan: getting a line of credit for your new business.
Having a line of credit will give your business access to funding that you can draw from as you need to. Unlike a loan, where you have to take and pay back a specific amount, a line of credit gives you access to withdrawing money when needed and paying it back; you also often have more control over the interest rate you pay too. These are helpful if your business is growing rapidly and you often have unexpected expenses.
What is a Business Line of Credit?
A line of credit for a small business is more like a credit card than a loan. It is a type of revolving credit which is designed to give your business access to money that you can draw from to cover business expenses. In contrast, a small business loan gives you a set sum of money that you have to make monthly payments on. A line of credit, like a credit card, accumulates interest when you draw money from it, and once you pay down your balance, the money is accessible again.
Loan vs a Line of Credit
With a loan, you are able to access a set amount of funds in a one-time lump sum which you then must pay back (with interest) over a certain period of time. But with a line of credit you are able to access funds repeatedly up to your limit. Similar to a credit card, with a line of credit as you pay off your balance (plus interest) you are able to use the remaining credit again. This is also known as a revolving line of credit.
For example, let’s say you have a $20,000 line of credit. You borrow $5,000, so now your remaining line of credit is $15,000.
Your monthly payment on this $5,000 is $500, but only $400 goes to the Principal and the other $100 goes towards Interest. So after your first monthly payment, your remaining line of credit becomes $15,400.
The next month, if you make your payment and you do not withdraw any additional money, you will have $15,800 available, and so on until you return back to your full line of credit at $20,000. At any given point in time, your remainder line of credit is available to you to withdraw and spend.
Using a Business Line of Credit
The main reason that a small business will open a new line of credit is because they need access to funding in the short term for things like expanding the business or operational expenses. A business that is more cyclical will often rely on lines of credit to provide capital in the off-season.
While a small business loan is usually intended for a specific purchase or purpose (like buying a piece of equipment or purchasing commercial real estate), a line of credit is meant to be flexible, so it is good for any expense that comes up that you need more capital for quickly.
Secured vs. Unsecured Lines of Credit
A line of credit for a small business is usually an unsecured debt, meaning you do not have to use collateral to secure it. An unsecured line of credit is usually available for up to $100,000. If a business needs a line of credit above $100,000, they will often have to secure it with a lien on their assets or certificate of deposit.
Why would a new business want one?
The main reason a new business would want to consider opening a line of credit instead of opting for a loan is that it is much more flexible than a loan. You can use the money for anything related to your business. You will also only pay for what you withdraw from the line of credit, so if you only withdraw $50,000 of your $100,000 line of credit, you are only paying interest for the $50,000 you have used. This is perfect for a new small business that needs access to ongoing funding, not just a single lump sum from a loan.
Additionally, a new line of credit for your new business will help you build credit for your business, so you can get access to larger sums for loans on more favorable terms. For this reason alone, it can be highly beneficial for a new small business to establish a line of credit, even if they do not need a large pool of funds to withdraw from right now. Plus, establishing the line of credit early means you already have it when something comes up, instead of having to apply for it when something unforeseen happens that you need funding for.
While a line of credit is similar to a credit card, they often have more favorable interest rates than credit cards do.
How to Get a Business Line of Credit for a New Business
Getting a business line of credit for your new business can be a relatively straightforward process. Let’s look at the steps involved.
1. Find What You Need to Qualify
There are some criteria that a business has to meet in order to receive a line of credit for their business. While each lender has its own specific qualifications, there are some things they typically have in common.
- Credit Score. Your personal credit score can be factored into the qualifications. Usually, you need at least a 680-credit score to qualify.
- Revenue. Your business’s monthly or annual revenue is important to qualify. Lenders often have a minimum requirement of $120k annually, but some fintech lenders offer lines of credit for small businesses that have not met that amount yet.
- How Long You Have Been in Business. To qualify for a line of credit you need a decent track record for your business, so many banks require a one-year minimum to qualify. Certain fintech lenders, however, will let you qualify after three months, which can help new businesses grow more quickly.
- Collateral. Ensure the lender you are going through does not need collateral, and if they do, determine what you can use for it.
It’s a good idea to look up what the specific lender you plan to go through requires for lines of credit.
2. Prepare the Paperwork
Next you need to get your paperwork together. Lenders usually require most of this information:
- Personal information: name, ID, social security number
- Business information: name of business, tax ID, industry, and entity type.
- Credit score: for your business and yourself.
- Financial information: revenue, bank statements, profit/loss information, and balance sheets.
- Tax returns: personal and for the business.
- Existing debt: amount, who it is through, and the debt schedule.
- Legal documents.
3. Apply for the Business Line of Credit
Once you know everything the lender will need for you to qualify and have gathered all of the documents the lender needs from you, it is time to fill out the application. This process and length will vary from lender to lender.
Once you get approved, make sure you know the following information:
- The amount you are approved for.
- Length of time you have to repay any withdrawals.
- The payment schedule.
- The interest rates.
- Any other fees on top of the interest.
Where to Get a Business Line of Credit
When you need a line of credit for your business, there are a few options available where you can apply for one.
Banks are one of the most common places for someone to go when they need a line of credit. If this is your first time looking for financing for your business, this is likely to be one of the first places you will go to seek the line of credit. However, the application process can be long, and banks often have more rigid qualifications in mind than some of your other options.
If you are a member of a credit union, you can apply for a line of credit through them instead of a traditional bank. They sometimes will have less strict qualifications, and the application process can be a little quicker than a bank.
The other option is to seek out financing through a fintech lender. They typically have a relatively simple application process that can take much less time than a bank. You can simply apply online, and connect your business bank account to the application, making it easy to prove your current financial information. Fintech lenders often have less strict requirements for qualification than banks do, but they might have a higher interest rate.
Other Funding Options for New Businesses
A line of credit is not the only way you can fund your new small business. There are many other options available.
Self-funding your business is where you use your personal savings, loans, credit cards, home equity, and retirement accounts to fund your business. This is something a lot of small business owners will do in the beginning, to supply their business with the money they need to grow and get off the ground.
When starting or expanding a new business, loans are one of the first things business owners will look into. If your business is brand new, you are more likely to qualify for a loan than a line of credit since lines of credit usually require you to be in business for at least a few months, if not longer, before you can qualify for one.
With a loan, you get the money in a single lump sum, and you have a fixed monthly payment, which can make budgeting a little easier. However, you might not be able to get a business loan for the entire amount that you need. If you need additional funds later, you have to apply again. Lenders often have extra fees for loans, and you need to provide some sort of guarantee or collateral.
One of the best options for funding for your small business is grants. Grants are essentially free money that can help you start or grow a business, but there is a lot of competition for grants. Grants require highly detailed proposals, and the process is lengthy for getting approved for a grant. It can take several weeks for a grant proposal to be completed; they are not something you want to put off until the last minute. You can have unlimited grants at any time, and once you get approved for one, it gives your business credibility and can make it easier for you to get future grants.
Read more: How to Apply for a Business Grant.
Crowdfunding has become increasingly popular in the last few years, as it allows a business to reach its target audience and get the funding they need to get off the ground or launch a new product line. Millions of creators have been able to raise money on crowdfunding websites, the most popular of which is Kickstarter, though there are many other crowdfunding sites out there. Crowdfunding websites essentially connect you with investors.
A line of credit can be an excellent choice for a new small business, but they can sometimes be difficult to qualify for. You can look into any additional funding options out there, too, including grants. Join Fundid’s Grant Match Program and search for grants in the Grant Marketplace to help your new business unlock more financing today!