Economic downturns and seasonal slowdowns can leave your business strapped for cash. But financial stressors aren’t the only reason you might need a quick cash infusion.
When you see an opportunity that will spur growth, whether it’s equipment that’s gone on sale or a timely marketing campaign that will build brand awareness, you’ll need cash fast. But that means you won’t have time to apply for a term loan or raise funds in other ways.
In situations like these, many businesses look to short-term lending options, such as business lines of credit. This type of lending is common among small to mid-sized businesses (SMBs) — 40% of small business owners in the U.S. applying for financing in 2020 sought a business line of credit.
Luckily, around 73% of those applications get approval, making a business line of credit a quick and reliable way to get cash.
But before you apply, you need to know the requirements and how you can prepare to increase your chances of getting approved.
In this article, we explain the main business line of credit requirements and the application process, so you have all the information you need to apply with confidence.
Understanding Business Lines of Credit
A business line of credit works like a credit card. You have a maximum amount of money you can borrow — otherwise known as your limit. When you use your business line of credit to make a purchase, you will have to pay back the debt.
But you only need to pay interest on the portion you spend. This can be an advantage for SMBs that can repay their balance quickly
How Do Business Lines of Credit Work?
A business line of credit is a practical way to manage cash flow and get some financial protection, especially if you tend to have slow months or slow seasons. The great thing about this type of short-term financing is that you can use it indefinitely, as long as you pay your monthly installments consistently.
For example, let's say you apply for a business line of credit and get approved for a limit of $50,000. You get a card that you can use to purchase anything related to your business.
If you spend $10,000 from your business line of credit, you only pay that portion back in installments, and you only pay interest on what you spent.
You can use a business line of credit to take advantage of seasonal sales and bulk purchases. You might get a more affordable deal when you buy inventory in bulk, which can help you expand your business and save money. When you don't have the cash to make the purchase, your credit line will come in handy.
You can also use it to pay for small everyday costs for your business — for example, if you need to replenish your office supplies or fill up your delivery truck with gas. When you can repay all or most of what you spend each month, you can keep your line of credit balance low and pay minimal interest.
Getting a line of credit has an advantage over a business loan: you can use the credit line anytime you want, and you have access to your credit limit for as long as you keep the account open.
With a term loan, on the other hand, you have to take out a new loan every time you need financing. Additionally, if you end up taking out multiple business loans, managing your loan repayments can become difficult.
The good news is that the arrangements are flexible with a credit line, so you can agree with the lender on the repayment period and the frequency of payments. Some lenders allow monthly or bi-monthly payments, so you can choose what works best for you. This flexibility gives you more control over your cash flow.
When to Get a Business Line of Credit
Many small business owners struggle with cash flow. In fact, cash flow problems are the number one reason why SMBs fail.
If your business needs a little boost to help with cash flow issues, a business line of credit can be the way to go. But that's only one of the reasons to get this type of business financing.
Here are some other things you can use this small business lending option for:
- Affording day-to-day expenses
- Covering fixed costs, such as utilities and subscription services
- Paying salaries for your staff
- Purchasing inventory or machinery
- Paying business taxes
Business lines of credit are incredibly helpful because, unlike small business loans, your line of credit is always available when you're in need. You can draw funds to cover unexpected business expenses. You can also use it to pay for operational costs during a slow season or while waiting for your clients to pay their invoices.
Basically, with this type of financing, you get peace of mind that you have a financial cushion to fall back on.
Secured vs. Unsecured Business Lines of Credit
Most lenders offer two types of business lines of credit: secured and unsecured.
Lenders approve a secured business line of credit for larger sums of money.
With this type of loan, you’ll need collateral to qualify. Your collateral assures the lender that if you cannot make your monthly payments, they can seize an asset of yours and cover the debt you owe. The benefit of secured credit lines is that they come with a lower interest rate.
An unsecured business line will have a higher interest rate and a lower limit, and it requires no collateral. The appeal of this type of financing is that it’s easy to qualify for.
Where to Get a Business Line of Credit
Like business credit cards, you can get a small business line of credit from various financial institutions. Let's look at your two primary options.
Banks and Credit Unions
Banks and credit unions provide both secured and unsecured business lines of credit. They usually have more competitive interest rates than online lenders, but the eligibility requirements are strict, especially around the stability of your annual revenue and experience in business.
That's why banks and credit unions are often a good fit for established businesses rather than startups.
While paying a lower interest rate is great for any small business owner, banks and credit unions will ask you for collateral more often than not, and they can charge additional fees, such as annual and inactivity fees.
In recent years, online lenders have become very popular for business lines of credit. An online lender has more relaxed requirements and greater flexibility. These two things are ideal for startups and businesses that don't have a great credit score.
If you go to an online lender for a business line of credit, they will process it quickly — and you might be able to get your business line of credit within days. The downside is that you might also have to pay higher interest rates for a lower credit limit.
Considerations for Business Lines of Credit
Getting a credit line for your business has a lot of advantages, but there are a few rules and stipulations you should be aware of. Let’s look at some of the factors you should consider before applying.
- Some lenders have draw fees, so anytime you make a withdrawal, you have to pay a fee.
- You might have a minimum withdrawal amount that depends on your limit.
- Inactivity fees are common, and you might have to pay those if you don't draw funds once within a period of time.
- You might need to pay an origination fee for the lender to process your application.
- Some lenders also charge account maintenance fees to manage and keep your account active.
Before you sign an agreement with a lender, check the small print for these conditions. You should also check out various options to find the best possible financing for you.
The Main Business Line of Credit Requirements and How to Apply
Whether you're applying for a secured on unsecured business line, both banks and online lenders have several application steps and requirements.
Lenders determine if you qualify by using risk-based models that take into account important financial aspects of your business. They often also need the business owner to prove that they have a good credit score or financial standing to qualify.
These requirements are in place so lenders avoid giving a credit line to a business that is unlikely to be able to pay it back. If the bank or online lender considers your application too risky, they will reject it, and you will have to look for other ways to improve your cash flow and finance business expenses.
Let's take a look at the application process and what’s involved, so you can determine whether you meet the standard business line of credit requirements.
Step #1: Submit an Online Application
Every bank, credit union, and online lender will have an application form for you to fill out. This is what they use to collect basic information about you and your business. This information includes your personal information, such as your name, address, and contact info. You will also have to outline business information such as:
- Business name
- Business address
- Business contact information
- The industry you operate in
- What services or products you sell
- The number of employees
- The reason why you are applying for a credit line
- Your ideal business credit line limit
Take your time filling out the application and make sure everything is correct.
Once you submit the application, the lender will contact you. Usually, the contact will be from a representative who will process your application.
Step #2: Hand in Supporting Documents
This step is an essential part of your application process. Your lender representative will tell you what types of documents you have to submit to support your application.
Some lenders will ask you to hand in these documents online as part of the application. Others will request documents once you've submitted your application.
Personal Credit Score
Even though you are applying for a business line of credit, lenders may ask for your personal credit score. They do this because you, as the business owner, are responsible for paying back your debt if the business cannot. This is called a personal guarantee.
So if your business goes bankrupt, you have to give a personal guarantee that you will pay back what you owe. If you are not the only owner, lenders will also consider your partner's credit score, and each one of you will provide a personal guarantee.
But what is a good credit score?
Lenders will consider 680 or higher to be a good credit score. That doesn't mean you can't get a business line of credit with a lower credit score, but the repayment terms, such as the interest rates, will be higher.
This is especially the case with traditional lenders, who expect a stronger personal credit history than online lenders will.
Business Credit Scores
Lenders will also look at the business credit score to help them decide if your business is stable enough to have a business line of credit and, if yes, what the limit should be.
If you have just started your business and it doesn't have a credit history, then lenders will only consider your personal credit score.
A crucial part of your application for a business line of credit (or any small business loan) is your business’s financial information. As part of your application, you will have to submit these financial statements:
- Cash flow statement
- Income statement
- Balance sheet
Lenders will use these to evaluate the overall health of your business, look into your business bank account to see the cash flow and match it with statements, and evaluate if your annual revenue is enough to qualify you for a business line of credit.
They will also calculate critical financial ratios such as your debt-to-equity ratio, current ratio, and fixed-charge coverage ratio.
They use these ratios to see if your other debt — a small business loan or a business credit card, for example — affects the business income to such a degree that you can't pay back the business line of credit.
Time in Business
Lenders know that small businesses have a high failure rate, and many won't make it past the two-year mark. So they are cautious about giving a business line of credit or any type of financing to very new startups.
Most lenders will not provide large credit line limits or unsecured lines of credit to businesses younger than two years. These businesses will also have a higher interest rate and shorter repayment terms. If you want your repayment time to be longer than five years, be prepared to offer collateral.
Availability of Collateral
If you want a business line of credit with a high limit, lower interest rates, and longer repayment time, or if you have a business that is younger than two or five years, the lender will also look at the availability of collateral.
Collateral ensures that if your business and you personally cannot make credit line payments, then the lender can rely on seizing your collateral to cover the debt and avoid losing significant amounts of money.
You also need collateral if you're applying for a secured business line of credit. To prove that the collateral is legitimate, you’ll need to submit documents showing that you or the business are the collateral owners.
Step #3: Wait for Processing
Once you submit all the necessary documents, lenders will process your application.
During this step, they’ll consider all the information you submitted, including your application, annual revenue, business tax returns, and business bank statements to determine whether you deserve an offer.
There’s one item within any lender's risk model that doesn’t reflect your personal credit or your business’s finances: industry type.
Each industry is assigned a risk factor rating regarding its typical success and failure rate. For example, the hospitality industry, retail, and real estate are more risky businesses, and lenders — especially traditional lenders — will be less likely to give you any financing if you have a very new business in a risky industry.
Step #4: Get a Response from the Lender
After processing, lenders will get back to you with an answer. This may be in the form of a phone call, email, or notification within the application platform.
Step #5: Use Your Business Line of Credit
If your business line of credit application is approved, you can start using the funds to improve your cash flow and grow your business.
If the application is denied, you have the right to ask for specific reasons. Once you understand why you were denied, you can work on improving your application and meeting the requirements, so you can try again later.
For example, suppose your application was rejected because your business doesn't have a long enough credit history or because the credit score is too low. In that case, you can work on improving it over the coming months and apply again.
Other Options for Financing
Business lines of credit are not the only financing instrument for small businesses. You can also apply for other types of business loans, including:
- Business credit card, which is similar to a business line of credit but may have a higher interest rate.
- Merchant cash advances, which take a percentage of your daily or weekly revenue to pay back a lump sum amount.
- Small Business Administration (SBA) loans, which are low-interest loans for small businesses and startups.
Business lines of credit can be a huge help for small businesses looking to grow. Qualifying for this type of financing starts with knowing the requirements and choosing the right lender.
If you're thinking of applying for business credit lines, then you can compare lenders and conditions in the best small business marketplace, AdvancePoint Capital.
AdvancePoint Capital allows you to apply in a few minutes, provides various financing options, and lets you choose what works best for your business.
Apply now to get started and receive financing in as little as 24 hours.