As of September 2021, more than 30 million small businesses were registered in the United States. For many businesses, loans enable development, help to grow faster, and can open up new opportunities. Contrary to popular belief, borrowing is not only necessary when a company has financial problems. Many entrepreneurs apply for a loan to achieve their future goals. However, they must choose a suitable type of loan to achieve business success faster. A line of credit is among the most popular type of business loans according to CNBC.
Small businesses that adopt a proactive approach to ensuring they have access to the resources they need to manage day-to-day working capital demands and other short-term financial needs can benefit from a business line of credit. It enables them to apply for and qualify for borrowed capital they may require in the future. To fuel expansion and fund other revenue-generating projects, many organizations use a line of credit as part of a comprehensive capital access strategy that includes both short- and long-term financing.
Line Of Credit As Business Funding
What is a Business Line Of Credit?
A small business line of credit is more like a credit card than a traditional loan. An unsecured line of credit gives businesses access to funds that can be used to cover any unexpected expenses. Unlike a small business loan, there is no initial payment that must be followed up with a monthly payment. Fixed monthly installment payments, you only pay.
A small business line of credit is revolving and is subject to credit review and annual renewal: Once you withdraw cash, interest begins to accrue, and the amount you pay (minus interest) becomes available to be borrowed again as you pay down your debt. The lender, like a credit card company, will impose a limit on how much you can borrow.
All LOCs have a specific amount of money that can be borrowed, paid back, and borrowed again as needed. The lender determines the amount of interest, the size of installments, and other conditions. A LOC can be secured with collateral or unsecured (with the need to present collateral), with unsecured LOCs often having higher interest rates.
When Should a Company Consider a Line of Credit?
Applying for a LOC may make sense if your company needs access to funds regularly to meet short-term capital demands and manage day-to-day capital requirements. Here are a few scenarios in which a LOC could be advantageous:
- A small business wants to increase its revenue by running several campaigns in parallel but at different times. It plans to use the revenue from the campaigns to repay the loan. A LOC equal to the total cost of all campaigns is a good way to avoid the administration and cost of borrowing more than once.
- For small businesses that operate seasonally, LOC’s can also be a financial solution to help them through periods of reduced income.
- In many industries, it is common for a company to agree in advance with a financial institution on a LOC solution. The contract is a kind of insurance against a difficult phase or a sudden development idea – but using it is not obligatory, it rather serves as a safety net.
As with all loans, it’s vital that you take out a Line of Credit when you can raise the funds to pay it back. The above examples illustrate the many situations in which LOC can be useful. Our customers typically use it for development purposes or to get through difficult times.
Secured Versus Unsecured Business Line Of Credit
What are the Business Line of Credit Types?
Secured Business Line of Credit
To secure this form of LOC, the company must pledge particular assets as security. Because a line of credit is a short-term obligation, lenders often want short-term assets like accounts receivable and inventory. Lenders don’t always demand substantial assets like real estate or equipment to acquire a line of credit. If the borrower defaults on the loan, the lender will seize possession of any collateral used as security and liquidate it to pay off the debt.
Unsecured Business Line of Credit
This sort of LOC does not require specific assets as security, but it will almost certainly require a general lien and personal guarantee. Because no specific collateral is required for this form of the credit line, the company will most likely need a higher credit score as well as a favorable track record to qualify. Furthermore, interest rates are likely to be slightly higher, and unsecured credit levels are frequently lower (more often $100,000 or less).
Which Business Line of Credit Type Should You Apply For?
There is a clear dividing line between the two financing solutions: can you or do you want to give the financial institution a guarantee. Or If your company is not yet in a position to take out a LOC with a significant amount of collateral, an unsecured business line of credit will be your best option.
What are the Benefits of an Unsecured Business Line of Credit?
You don’t have to provide collateral
If your company does not yet have any major assets of its own (such as real estate or machinery), you will not be able to provide a company guarantee for repayment. In this case, an unsecured business line of credit will be your best option.
The traditional line of credit has way more stipulations
Although it may sound surprising at first, the secured LOC imposes many more restrictions on your company than the unsecured alternative. The reason is that you can request a higher amount of money with collateral, which in turn carries a higher risk for the financial institution and therefore imposes stricter conditions on you.
Fast approval procedure
One of the biggest advantages of an unsecured business line of credit is the speed of processing. Since there is no collateral, there is no need for the lengthy administrative process where the financial institution must take the asset offered as collateral (such as a mortgage on a property).
Faster disbursement
LOC’s is a quicker-to-proceed loan type, but the unsecured type can be in your account even faster.
Lower credit requirements
Also linked to the lower amount is the fact that the credit requirements are less stringent than for secured LOC’s.
Cons of the Unsecured Business Line of Credit
To get a complete picture, it is necessary to talk about the strengths of the secured LOC. These include the higher credit line limit amount, lower loan interest rate, and longer terms. For these reasons, a secured loan is usually the right solution for medium and large businesses.
How To Apply For Unsecured Business Line Of Credit
What Does It Take to Get an Unsecured Business Line of Credit?
Each lender’s credit approval requirements for an unsecured business line of credit may change significantly. You may expect the following common elements to come into play:
- Is your personal and/or corporate credit history in good standing? As part of the application process, most lenders will check your credit records.
- What is the annual income of your company? A lender may need proof of a certain amount of income (e.g. $50,000, $100,000, etc.). Verification of tax returns and other financial statements may be sought.
- Have you been in business for a long time? Many lenders may demand that your business has been in operation for at least one to two years.
- Do you have a credit score that meets the minimum requirement? It might be your personal credit score, your corporate credit score, or a combination of the two.
- Do you have a strong vision of what you need the LOC for? A well-crafted business plan helps the financial institution to understand your position.
- Is your business financially healthy? A strong cash flow history helps the lender to offer better terms and conditions for the unsecured business line of credit.
Can I Apply For An Unsecured Business Line Of Credit With A Bad Credit Rating?
There are several small business financing choices for those with negative credit, contrary to conventional opinion. Keep in mind that each loan choice is unique and comes with varied approval rates. In our experience, the approval rate for merchant cash advances is the highest (85 percent ).
In the case of a LOC, the lender considers a number of additional aspects before making a decision. Merchant Funding Solutions also considers the feasibility of personal collateral, the term length, the loan amount, and the loan’s purpose.
An unsecured business line of credit can be an excellent solution in many cases. If you are looking to develop or grow your business in a difficult time, contact us. Our advisors will be happy to help you find the right business funding.
