Is a Business Line of Credit a Good Idea?

If you are growing your company or need capital to cover everyday expenses, a business line of credit can be a good idea. If you need fast access to funds, you could apply for a loan; however, that could take too long to help you with your urgent requirements. Additionally, about 30% of small business loan applications are denied, leaving you strapped for funding.

Like other financial products, business lines of credit come with advantages and disadvantages that should be assessed for your company.

Whether a business line of credit is a good idea will depend on your company’s stage of business and its particular needs. Here are ways to look at this financial tool to help you decide whether it could be a good decision for your enterprise.

More About Business Lines of Credit

A business line of credit provides access to capital for companies to bolster their short-term financing needs. It offers additional flexibility that traditional business loans aren’t underwritten to do.

A business line of credit allows you to borrow up to a pre-set credit limit (say, $125,000) and only pay interest on the part of the funds that you utilize. You can then withdraw and repay money whenever necessary, as long as you stay beneath your credit limit.

Requirements for a Business Line of Credit

Before a bank or credit union extends a small business line of credit, your company will need to fulfill a specific set of requirements. While you aim to acquire funding for your business, the lender is looking to make money off your repayments. If the lender determines you and your business are too risky as a borrower, then you may have difficulty being approved for a line of credit.

To determine your interest rate, lenders typically use risk-based pricing: if you are a high-risk borrower, you will receive a higher interest rate. If they consider you to be a safer bet, you will receive a lower interest rate.

Though actual credit requirements will vary depending on the lender, here are some factors they may look at:

Your Individual Credit Score

Because a business line of credit requires a personal guarantee, you will likely be on the hook if your company can’t repay the debt. This is the reason lenders will want to examine your individual credit history. To ensure you can make good on your personal guarantee, banks will run a hard credit check, which can affect your credit score.

Poor credit may limit your credit line options, and you will likely end up paying higher interest.

Your Business Credit Score

Lenders will likely check your business credit reports and scores in addition to running a personal credit check. If your company is new or lacks a credit history, the bank will depend mostly on your personal credit score.

If your firm has an established business credit history, bankers may utilize it to decide on whether or not to lend to your company.

Your Company’s Financials

Your personal and business credit scores are vital components that bankers and other lenders use to determine your creditworthiness during the underwriting process. However, there are other considerations. Lenders may also look at financial ratios, including your:

  • Fixed-charge coverage ratio
  • Current ratio
  • Debt-to-equity ratio
  • Debt service coverage ratio

You will also likely need to provide your company’s:

  • Profit and loss statement
  • Balance sheet

The Industry in Which Your Business Operates

Retail, restaurants, and real estate are business industries many lenders consider risky. However, if you have experience in your chosen industry, it shows bankers you are less of a risk than entrepreneurs new to the industry.

Pros to Opening a Line of Credit

To decide if a business line of credit is a good idea for you and your company, let’s look at some of the pros:

  • Credit lines are flexible—Other types of business loans extend funding in a lump sum, and you are required to pay interest on it all at once. A line of credit gives you the flexibility to decide on the amount of funds you need to use over a given period, and you only pay the interest on the amount you use.
  • Business lines of credit are revolving—A business line of credit can be held open for a longer time than standard small business loans. This benefits you by giving you access to funds anytime you need them without having to reapply.
  • They can help you build credit—If you can pay your monthly payment on time or early, you can help rebuild your credit score over time.

Cons to Opening a Line of Credit

Opening a line of credit may not work for every business. Let’s look at some cons associated with this type of financing:

  • Extra fees—Some lenders charge you annual maintenance fees and other transaction fees on top of the regular interest rates you must pay. These fees do not apply to small business loans or alternative funding sources like the new Revenued Business Card.
  • Must be operational for at least two years—Many lenders refuse to grant lines of credit unless you have been operating your company for at least two years. With the Revenued Business Card, you only need six months of operational history.
  • You need good credit—You will likely need a credit score of at least 680 to qualify for a line of credit with decent interest rates. This can preclude many business owners whose credit scores took a hit during the pandemic.

Consider Revenued’s Alternative to a Business Line of Credit

If, after weighing the pros and cons of a business line of credit, you decide it’s not for you, consider the Revenued Business Card. To be first in line when the application for the new Revenued Card is available, join our waitlist today.

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