Business Debt & Credit

Business Line of Credit

The business line of credit account is one form of credit that you absolutely need if you have been in business for awhile. The business line of credit in its simplest form is a line of credit you establish at a bank, usually between $5,000 and $250,000 that you can tap into — anytime! — by check or credit card when you need money. It differs from a business loan, which usually furnishes you with a set amount of dollars that you then pay back over a number of years at a set interest rate and a set monthly payment. The business line lso differs from the business credit card because the line of credit typically will not cost you anything to access, whereas the business credit card will. Of all three ways to access money, the business line of credit is usually the cheapest.

The Business Line of Credit…Handle with Care!

Although the business line of credit is absolutely essential for 99 percent of small businesses today, as effective and as important as it is, it can also be hazardous to your business. Why? Because with this amount of credit available, debt can sneak up on you and bite you. Before you know it, rather than having a flexible spending account, you are carrying around a heavy mountain of debt.

It can also allow you to overlook (or ignore) problems in your business that you should face immediately. For example, if you did not have the business line of credit and you lost a big account, you would need to take immediate action to cut costs like getting rid of employees or getting rid of your office. With the business line, however, you can stretch things out for a few months to try to get another big account. After a few months (with no new big account), you will need to begin major cost-cutting measures that you should have undertaken months before, only now you have massive new debt to pay as well as a need to cut costs.

What follows are tips to find, manage and stay on the good side of a business line of credit.

  1. Always get a business line of credit (LOC) before you need it. If you wait until you absolutely require it, it may be difficult to get in a timely manner. Further, if you get it at a time that you do not need it, you can on occasion pay bills with a business line of credit check and then promptly pay off the money you have used. For example, if a $10,000 bill for supplies needs to be paid, even if you have the money in your checking account, pay it with a line of credit and then repay it in two or three weeks. It will make your lender feel comfortable that you are managing your business line of credit account as it was intended…to smooth out the peaks and valleys in your small business. Over time, they will likely increase your limits on what you can borrow…Over a two-year period, you can often get your LOC account up to a tidy sum in case of a real emergency.
  2. Prepare your business and your banker before you apply for a business loan. If you start a new business in September and go in to apply for a hefty business line of credit in October, chances are slim that you will get what you are after, with one major exception. If you, Mr. or Ms. Entrepreneur have stellar credit, the bank is likely to furnish your business with a line of credit account with your business name on the account and on the checks. The thing is, you, the possessor of stellar credit, will be personally liable for any amount that is borrowed by the business. This is also true if you set up your business as a sole proprietorship or partnership. If you set the business up as a C corporation, chances are that you will probably wait a long time to get unsecured credit through the corporation. With small businesses, banks like that owner to ultimately be responsible for any debt.
  3. Business line of credit interest rates are usually less than either business credit card rates or business loan rates. Most business lines of credit are based on of a standard measure like the prime interest rate plus a few percentage points tacked on. The prime rate is the interest rate that the bank’s best, most credit-worthy customers like IBM or GE might receive. That means that if the prime interest rate is two percent and your loan is three percent over prime, you are paying around five percent for your loan. If you have borrowed $10,000 on your line of credit account, the cost of that money will be around $500 a year. If the prime rate were to suddenly jump to six percent — and that can happen — you would be paying six percent + three percent or nine percent for that money. You would be paying $900 a year in interest costs. In the early 1980s, the prime interest rate jumped to 20 percent!
  4. Ask about interest rate protection when you apply for the business line of credit. Some banks have a program through which you can receive some protection from interest rate jumps. Naturally, if you took out a fixed-rate business loan, that rate would stay constant throughout the life of the loan, unless there is something in the terms and conditions that states otherwise. Always read and understand the terms and conditions of all money matters.
  5. Use care when working with non-traditional lenders. You know about Chase Bank, Wells Fargo, Bank America, etc., but what do you know about some of the online sources of money? For both traditional lenders and for nontraditional lenders, always carefully read over the terms and conditions of the contract they are imposing for you to borrow money. Note with care the terms and conditions of making a late payment: what do your loan repayment interest rates jump to if you are late on a payment?
  6. Don’t carry a constant amount on your business line of credit account. The bank wants you to use the money to cover peaks and valleys, so pay off the line of credit from time to time to make the banker feel more secure and to keep that line of credit open. If you have a maxed out $50,000 line of credit, you are vulnerable to having the rug pulled out from under you if the bank perceives a dip in the economy or if the bank changes its lending criteria and small businesses like yours are no longer desirable to them. They can and will do it and at the worst possible time. It should be one of Murphy’s Top Ten laws!
  7. What is a business line of credit. It is a powerful tool, a highly flexible way to borrow money instantly from the bank when you need it, but it is a tool that can turn against you and hurt the business is if not used properly. That line of credit from your bank is not a lifetime commitment, so keep that in mind. As the Great Recession started in 2008, many banks simply closed many a small business’ line of credit accounts. We know of instances where small business had a business line of $250,000 that was gone overnight as were five employees who he had to layoff.
  8. Develop relationships with more than one lender for business lines of credit. If you need a $20,000 business line of credit, it is probably better to obtain it from more than one bank. Banks change lending policies on a dime and if you have a relationship with just one bank, your business line of credit account could be lowered or shut down for no other reason than the bank is changing its lending criteria and you and your business are on the wrong side of that lending criteria.
  9. Expect that banks will charge maintenance fees for maintaining your line of credit, whether or not you use it. Typical might be a $150 annual fee for the line of credit. Even if you never intend to use a business line of credit to cover expenses, it is a great “insurance policy” for $150 a year.
  10. The typical lines of credit range from $5,000 to $250,000 for small businesses.
  11. The business line of credit is meant to smooth out the peaks and valleys of an established business and lenders have no interest in you using the line of credit to fund a startup. Saying that, many entrepreneurs with decent credit scores and credit reports will use personal lines of credit, credit on credit cards and home equity lines of credit to fund their startup. They are fully liable to personally repay all of that money.
  12. To establish a business line of credit, be prepared to show the bank your business financial statements and tax returns for the past two years. Get in the habit of using Intuit’s Quickbooks program or another accounting program to produce clean, crisp documents, even if you have a tiny business.