It is very common for potential clients to ask themselves a variety of questions when they consider getting a line of credit for their business. Is the process difficult? What options do I have? Where do I start? Well, getting a business line of credit can be both simple or difficult, depending on the type of credit you’re seeking and your qualifications as a borrower.
A line of credit is a type of loan that a lender extends to an individual or business. It allows you to borrow, or draw down, money for a specific purpose. For example, a business line of credit, which we’ll discuss later, acts as sort of a safety net for your business. You can dip in to funds to cover various small business needs. Think of it as having more in common with a business credit card than a traditional small business loan.
How is a line of credit different from a regular loan? With a line of credit, you are only charged interest and fees on what you borrow. With a traditional loan, you receive a sum of cash and are obligated to start making payments on the balance immediately.
So, if you take out a business line of credit, but you don’t withdraw any money, you won’t have to pay any interest on it. That being the case, you can still access the balance for qualified purchases at any time. You only make payments on money you’ve withdrawn.
First, let’s briefly go over the main types of lines of credit. An unsecured line of credit is rapidly becoming the most common line of credit. Although this type of funding was commonly offered in the past, this instrument was scaled back during the 2008 recession. Now, we are seeing a better, smarter product hitting the market. In many cases, if a business owner is wondering what line of credit they should apply for, this is likely the product that will fit.
An unsecured line of credit is a revolving line that is not backed by any particular assets. Qualifying for this type of line of credit is based mainly on the financial health of the business.
An equipment line of credit is a pre-approved line used solely to purchase equipment. These lines of credit can cover anything like heavy machinery, software and much more. Approval by the lender is based on the financial health of the merchant, and the piece of equipment’s benefit to the business. The equipment must be used in the standard functions for that industry.
An asset-based line of credit is a type of secured line of credit. This line is secured by assets that have already been acquired by the merchants. Essentially, if the business seeking the loan can’t show sufficient cash flow or assets to cover a traditional loan, the lender may offer to approve the loan with its physical assets as collateral. For example, a newly formed cafe might be able to obtain a loan only by using its equipment as collateral. The collateral could include items such as equipment, receivables, inventory and more.
Commercial lines of credit allow you to access funds on an as-needed basis. They’re pre-approved amounts that can be accessed by your business at any time to help meet various financial obligations, like everyday operations. Once you’re approved, you’ll have ongoing access to funds. Commercial lines of credit can also be used to prepare for unexpected expenses and to help fund new business opportunities. A benefit of this line of credit is that you only pay interest on the amount you use. The borrowing business usually pays back the lender once funds become available.
To qualify for an unsecured business line of credit, lenders generally analyze the creditworthiness of the business, as well as three to six months of bank statements. Usually, businesses only need to provide three months of bank statements, but additional statements may create a clearer picture and help secure better funding terms.
An equipment line of credit and an asset-based line of credit both share a common characteristic in that they are both secured with assets. The most significant difference is that an equipment lines of credit is set up without a specific use in mind, whereas certain specified assets back a general asset-based line of credit. The reason for the difference is that generally the merchant is given access to that the ABL Line once the proper assets have been properly secured. Alternatively, the equipment line is approved up to a specified amount but is only accessed once the merchant has chosen to acquire the asset. There is a second step to the process where the invoice, vendor and equipment still need to be approved before the draw is funded.
For an asset-based line of credit, lenders generally like to look at the credit strength of the business and examine the financials of the company. If that is all acceptable, they then value the assets to understand how much we are comfortable funding given the value of the security interest pledged.
For an equipment line of credit, business lenders base the approved line amount initial on three factors: the credit of the business, the creditworthiness of the business owner or owners, and affordability aspect for the merchant. Once the line has been established, the second step in the approval process is to examine the type of equipment, approve the equipment seller, and ensure that the equipment applies to that particular business. This is a fast process that allows the vendor to get paid quickly, many times, even before the equipment has been delivered.
So, we’ve covered the various lines of credit, their processes and how to apply. Here’s a simple, general guide to applying for business lines of credit: