A Small Business Line of Credit : Pros And Cons
A small business line of credit works like a credit card, except that it is revolving and subject to frequent credit checks and annual renewal: interest starts to build when you draw funds, and subsequent repayment (unless you pay an additional fee) is available to be withdrawn when you settle your balance.
Unlike a credit card, you can only use a small business line of credit for a particular amount of time the maximum amount you can borrow is determined by your company’s credit limit and maximum assets. If you run out of credit regularly, you may not be able to keep your account open; even if you can keep it open, you might be assessed late fees or higher interest rates. If you need a large amount of cash up-front to meet immediate needs, you should consider applying for a personal loan, which generally requires less documentation and approval.
You should keep in mind that a business line of credit is not a “payday loan,” since the funds you can borrow are only available upon receipt of your payment. Once your account is opened, you are charged interest on any funds in your account. You cannot use these funds for anything but emergency expenses, such as a bill due or car trouble. Your account is considered “open” when you have not repaid a bill in full for three months or more. Some lenders allow you to extend your revolving line of credit for an additional year, at a cost.
A small business line of credit comes in two forms: one-year and two-year. A one-year facility provides you with up to ninety days of uninterrupted funds. During this period, you are permitted to make one single, low-interest payment to borrow funds. You will then be charged one percent of this amount for the remaining balance, plus a one-time administrative fee. This means that you are only allowed to borrow funds once per year.
On the other hand, a two-year small business line of credit limits you to up to three hundred thousand dollars at the most. You can only borrow this amount during your term; therefore, you must repay the entire loan amount, plus a one-time administrative fee. You may borrow up to three percent of this amount, plus a fixed rate. You will be charged interest on the money you borrow, which is also capped at fifteen percent.
One advantage of this type of financing is that you do not have to obtain a working capital loan if you do not require it. Since your business has already started operation, you do not have to apply for a working capital loan. Furthermore, since the funds used for a working capital loan are repaid during the start-up phase of your business, this type of financing does not negatively impact your cash flow.
Another benefit is that you have greater borrowing power. Since you do not have to obtain a working capital loan, your working capital is not reduced. This means that your potential for future borrowings is greater when you use a two-year small business line of credit instead of a one-year option.
There are also some disadvantages of a small business line of credit. Because you do not need to obtain a working capital loan, there is no security provided by the lender. Since the funds used to start operations may not be available in the future, you must rely on your personal credit history and personal finances. Some businesses also find that the costs incurred to obtain this financing are higher than the cost of the funds they receive. These expenses include application fees and other administrative costs.