Fundid Aug 3, 2021 2:26:35 PM 7 min read

What is a Business Line of Credit? Should You Use One to Fund Your Small Business?

Women entrepreneurs are thriving in the U.S. According to Fundid, women owned businesses generated close to $2 trillion in revenue and employed millions of Americans in 2019.

But despite making this significant contribution to the economy, most of these businesses are categorized as small businesses because they employ less than 500 workers.

Great news is: that's changing.

For many years, access to funding has prevented women entrepreneurs from growing to their full potential. But today that trend is reversing as more funds and grants are availed to women through:

  • Private business grants specifically for women
  • Federally sponsored grants
  • Small business loans
  • Venture capital funds
  • Crowdfunding

Under business loans, many women business owners are turning to lines of credit to grow their ventures. If you haven't, here is what you should know:

What Is A Line Of Credit?

A business line of credit is a type of loan that offers more flexibility than ordinary loans. Here, business owners can borrow as much money as needed up to their limit, which usually falls between $1,000 and $250,000.

A line of credit can be a great source of money for women-owned businesses. Instead of getting a lump-sum amount, you receive a revolving line of credit that you can use, repay, and use again over a specified period.

Types Of Business Line Of Credit

  • Secured vs. unsecured: a secured line of credit means you're using assets like business property or inventory as collateral. An unsecured line of credit, on the other hand, doesn't require collateral.
  • Real estate line of credit: It's equivalent to a personal home equity line of credit (HELOC). For business, you use your home's equity or equity in other properties to secure a loan.
  • Business credit cards: like personal credit cards, business credit cards offer quick access to cash without collateral.

If this financing option looks appealing, it's important to note that the requirements may be different from other types of loans.

General Requirements For Business Line Of Credit  

When applying for business loans, your goal is to get the funding. But the lender's goal is to get repaid at a profit. Lenders, therefore, look at many factors before providing the loan.

While the actual line of credit requirements may vary from one lender to another, here are some general factors they may consider:

Personal Credit Score

Although it's your business that's borrowing, lenders may still look at your credit score for two reasons:

  • Personal guarantee: This means you will be held responsible for repaying the debt if your business can't.
  • Chances of repayment: lenders want to be sure the borrower has skin in the game to increase the chances of getting repaid.

To check your credit score, lenders usually conduct a background check. You need a good credit rating of above 680.

If your score is lower, you can still get a business line of credit. However, your options will be limited and you may go home with a high-interest rate.

Business Credit Score

Apart from running a personal credit check, many lenders may look at your business credit score and reports. Financiers use this information to determine the risk of lending to your business.

If your business is new or doesn't have a credit history, then your credit score may be lied upon.

Business Financial Statements

In addition to looking at your business and personal credit scores, lenders also consider your profit and loss statements and your balance sheet before advancing the loan.

And here, lenders use ratios such as debt to equity, fixed charge coverage, debt service coverage, and current ratios to ascertain your ability to repay the loan.

For instance, many lenders calculate your debt service ratio by dividing your net operating income by your current liabilities for one year. Ideally, this figure should be above 1.25 as it means your operating income is 125% of your liabilities.

The higher the ratio, the better, because it means you're more likely to get the funding on favorable terms. And just like credit score, you can still get approved for the loan if you have a lower ratio. However, you may not get favorable terms.

Fundid Grants

Time In Business

Thousands of businesses close shop every year. According to the Small Business Administration, only 50% of businesses make it to their first anniversary.

And this is probably why financial institutions are cautious about lending to businesses without a proven track record. Before approving your line of credit, lenders want to see you've successfully managed your business for two years. If you haven't run that long, you may not find a low-cost line of credit.

What Are Lines Of Credit Used For?

A business line of credit can be used to finance short-term working capital tasks, such as:

  • Purchasing inventory
  • Marketing campaign
  • Repairing business equipment
  • Bridging seasonal cash flow gaps

Pros Of Business Lines Of Credits

  • Flexible: This allows you to borrow what you need and has few restrictions on how to use it.
  • Lower interest rates: lines of credit attract lower interest rates than credit cards and payday loans.
  • Continuous access to funds: since it's a revolving line of credit, you can borrow and repay repeatedly.
  • Quick and easy: get approved within minutes, making it perfect for women entrepreneurs who can't wait.

Cons Of Business Lines Of Credit

  • Requires good credit: lenders usually reserve business lines of credit for borrowers with excellent or good credit scores.
  • Maintenance fees: Some lenders subject lines to credit to maintenance, late, and returned payment fees.
  • Can damage credit: if you don't pay on time or carry high balances over time, business lines of credit can impact your credit score.

Funds are the cornerstone of businesses. Without it, you may not be able to grow your business. For more tips on where to get funding and how to do it, search for funds and grants in our Grant Marketplace.

Friday Fund