A business line of credit is a flexible short-term loan that can be an incredibly handy tool for small to medium-sized businesses that need a little helping hand to reach their potential on a day-to-day basis.
A business LOC is simply a loan format that can be used for many versions of business lending. Sometimes, before we can establish what can be done with a business line of credit loan, we have to give it context.
For example, you may take out an inventory loan as an LOC. An inventory loan is predominantly used to acquire stock, and that stock acts as the collateral on the loan.
As such, you can only spend the borrowed amount on inventory, but there are other more general business lines of credit that have a much wider application. You can use them to…
- Repair Equipment Critical to Business Functionality - Say, for example, you own a small newsagent store, and your fridge or cooled area containing sandwiches and other snacks went down. You could use your line of credit to get it up and running again, saving those sandwiches from their impending doom.
- Augment Branding and Market Strategies - Perhaps you want to purchase some signs or rework your brand. A business line of credit can help you achieve these things.
- Survive Quiet Seasons - Most businesses have busy and slow seasons, and sometimes, surviving the slow season is tough. In many cases, a business line of credit might be the only thing keeping you going until that busy season comes back around.
- Make Payroll Purchases - Everyone loves payday, but before you can give your staff their hard-earned wages, you need to access it. Unfortunately, though, using the standard business credit account for payroll purchases means you’ll have to pay cash advance rates that can end up being more than 20%. Your business LOC will more than likely offer a much better interest rate, so it makes sense to use it in place of your normal credit account.
- Develop Working Capital - If you receive payment for a product that you custom-make to order after labor has concluded, how are you going to pay for the materials? The answer is of course a business LOC.
These are just a few examples of the things you can use a business LOC for, but the sky’s the limit. Pretty much any commercial short-term financial issue can be alleviated with one of these nifty loans.
The Significance of Short Term Purchase with Business LOC
Short-term really is the key phrase when thinking about how you can use a business LOC. You should never rely on it for long-term purchases that stretch beyond a year.
They’re designed to help you cover the costs of items or services that you’ll ideally be able to pay off in around 30 days.
If you need to make longer purchases with payments spanning multiple years, a standard term loan is by far your best option.
It’s also important to note that, as a business loan, you will not be able to make personal purchases with the funds. Every expenditure you make with the LOC account must be completely business-oriented.
How does a business line of credit work?
Have you ever used a credit card? Then you’ll already know the basic concept of a business line of credit loan. Essentially, a sum is agreed upon by the lender and borrower. Let’s say that sum is $200,000.
This $200,000 isn’t transferred in one lump sum to your account like a standard term loan, rather, it’s held in another account, a sort of credit pool that you can dip into when you need it.
The line of credit will be available to you for a predetermined period which is usually around six to twelve months, but it can be longer if necessary.
When you take some of the money out of the credit pool, you’ll be required to pay interest on the sum you’ve borrowed, no matter how small. However, the interest is calculated on the amount you use, not the whole available sum.
For smaller LOCs under $100,000, you’re usually able to access the funds using a credit card that’s tied to the line of credit rather than your actual account.
It’s also possible a lender will encourage you to bill your expenses to the line of credit via check.
Alternatively, some lenders may allow you to draw LOC funds directly into your business account using an ACH deposit.
Business line of credit loans are revolving. This means that you can take some of the money out of the $200,000 credit pool, perhaps for equipment repairs, and once you’ve repaid it plus interest, the credit pool fills back up again.
You can essentially think of the repayments as replenishing the credit pool.
Revolving LOC loans offer tons of flexibility, helping business owners deal with whatever the immediate future brings.
As the line of credit fills back up after repayment, you can utilize it in a strategic manner to help maximize the profitability of your business. Now let’s discuss the two types of business LOC loans available to you.
Secured Business Line of Credit Loans
A business line of credit behaves much like any other term loan agreement - trust is built by establishing collateral in the form of your assets.
As a business line of credit is almost always a short-term loan, the lender will prioritize short-term assets such as securities, accounts receivable, and inventory.
You’re always more likely to succeed in securing a line of credit when taking the secure route as there is less risk involved for lenders.
If you fall behind on payments, they can simply recoup their losses by seizing and liquidating your assets.
This safety net means a lender is more likely to be lenient when it comes to your credit score and interest rates, so secured LOCs are often the best course of action.
Unsecured Business line of Credit Loans
Unsecured business line of credit loans are the opposite. A lender offering this service will not require collateral, but that’s not to say they’re going to go into this agreement without any assurances at all.
Generally speaking, a lender will still require a personal guarantee, which means a third party (person or organization) promises to pay your debts should you fail to.
As this still doesn’t provide all that much security to a lender, you’ll also need to prove your worth with a strong business credit score and business track record.
Even if your credit scores and business track record are exquisite, this only provides hypothetical security to the lender.
As a result, you can still expect them to try and sweeten the deal for themselves with higher interest rates and smaller lines of credit.
- Borrowing Amount
For a secured business LOC, the maximum amount you can borrow tends to be around $250,000, with the average sum for an unsecured business LOC falling just shy of that figure.
However, you by no means have to go big with an LOC. One of the best things about them is their range. If you wanted to keep your borrowing to a minimum, you can request something to the tune of $10,000 in your LOC.
Ultimately, how much you’ll be able to borrow on a secure LOC will depend on the liquidation value of the assets you have pledged to the lender as collateral.
Using our inventory loan example again, most lenders offer between 70 and 100% of the liquidation value of the collateral.
So, if the open market costs of the stock you plan on buying comes to $250,000, an independent appraisal might state that its liquidation value is roughly $200,000.
This means that a 100% offer would amount to $200,000 rather than the full $250,000, and a 70% offer would come to $140,000.
- Repayment Plan
As I’ve already touched upon, business LOC loans are a short-term lending format, so you can expect everything to be tied up in a neat bow within a year.
LOCs are normally repaid monthly, but it’s possible to set up weekly payments if the lender agrees.
Typical interest rates for business lines of credit can range from 2.58% all the way through to 80%, although it's not unheard of for interest rates to hit 100%.
- Extra Fees
If you’ve signed up for a business LOC, it’s important to be aware of the fact there might be an account start-up fee, account transaction fees, and annual account fees.