One of the major challenges that business owners face is raising capital. The challenge is even greater for startups. Sometimes the available capital is insufficient to maintain a steady cash flow. Some business owners opt for a line of credit to pay off their expenses. In this case, the lender sets a specific amount that a business can withdraw every month. The business will be required to pay the credit debt or pay the interest or fees on the loan. A line of credit is a viable option when a business is facing a financial crunch but it has its pros and cons.
Pros of a Business Line of Credit
A business line of credit enables business owners to pay off their expenses as they fall due even if they do not have cash at hand. Consequently, they meet their customers’ needs on time. The line of credit also offers flexibility on the way businesses spend the loan. Businesses do not have to withdraw the full amount granted at once. They can withdraw an amount that covers the pending expenses and then pay the interest or fees on that amount.
Access to Unsecured Funds
One of the biggest advantages of business lines of credit is that they offer access to unsecured funds. Meaning that you usually won’t have to submit collateral to get access to a line of credit. And also, contrary to a regular loan when you have to pay the interest on the whole amount borrowed, lines of credit are in many ways similar to credit cards as they only require you to pay interest on the funds you have used. Also, lines of credit for businesses can be expanded for much longer than regular business loans, which eliminates the need to reapply for a loan. And finally, being in good standing with your line of credit is a great way to improve your credit score, which is great if your business is still young and you haven’t had the time to build your credit.
Building strong relationships with lenders is critical at all stages of business growth. Loans from banks can help business owners grow their business faster when used properly. When a business uses a line of credit well, it can access larger loans in the future. A good relationship with a lender enables business owners to negotiate for fairer interest rates and repayment periods.
Business owners can raise capital by selling part of the business equity, spending personal savings, or borrowing from banks. It is almost impossible to save enough money to grow a business to a leading position in the market. A business line of credit enables business owners to acquire funds and maintain their business equity.
Cons of a Business Line of Credit
Getting a line of credit is risky. The expectation is that the business will make enough sales and profits to cover the loan amount and any fees or interest. In the case of a sole proprietorship, business owners will usually have to pay off the loan and interest with their personal funds when their companies go out of business. Poor management of funds can lead to a situation where a business draws more from its line of credit than it can afford to pay. The line of credit puts the business in debt even if the business draws a small amount every month.
Most lenders are reluctant to offer any loans to startups and small businesses. Every lender requires proof that a business can repay the loan. Lenders ask for financial statements and tax returns before issuing loans to businesses. Some limit their credit to businesses that are at least two years old. New business owners often have no way of assuring lenders that they will repay a loan. Consequently, they cannot get a line of credit when they need it most. By the time a business qualifies for a loan, the owner has either used up his or her savings or sold part of the equity.
A line of credit enables businesses to pay off their expenses as they fall due without selling their equity. However, business owners cannot rely on loans at the early stages of their business because most lenders do not lend to startups. But business lines of credit offer a level of flexibility regular loans can’t and can be a literal life saver if your business is struggling with cash flow.