by Linda French Mar 15, 2022Share On:
A business line of credit for startups is known as a Line of Credit (LOC), which is a helpful instrument for helping business owners deal with unexpected expenses or revenue fluctuations. Having a line of credit to draw from can mean the deciding factor of whether the company is going to fail or survive. LOCs, like any other type of loan, must be repaid-with interest. Therefore, it is critical to consider how best to employ this funding option.
Here's everything you need to know about business lines of credit and how to use them.
What Is a Business Line of Credit?
A line of credit (LOC) is an agreement between a bank or other financial institutions and a customer who can be either an organization or individual, to provide funding such as SBA loans for a startup business, SBA loans for real estate, SBA loans for minorities, up to a particular limit. The customer can withdraw cash up to that limit at any time and is responsible for paying interest on the amount borrowed until you repay. After repayment of the secured business loan, the consumer might borrow the cash again to meet additional expenses.
A business line of credit for startups differs from other conventional business financing choices. However, it is similar to a credit card. They both work by letting the borrower draw money indefinitely up to a particular limit. A LOC differs from a credit card because it involves the signing off of a valuable asset such as a home or business as a guarantee which often results in lower interest rates (about 3% to 7%) and higher credit limits than credit cards.
A secured business loan is a popular startup funding for small businesses. You may use a business asset, such as a LOC, to secure it. Secured business loans, unlike a line of credit, is paid back in fixed payments that can last anywhere from three months to 25 years. With a LOC, repayment is typically due monthly on the amount borrowed, and interest is charged only on the portion of the loan not paid on time.
What Time Is Business LOC Best Used?
When you know you'll be able to repay the funds in no time, a business line of credit is the ideal option. As a result, business owners that rely on LOCs to fund routine business operations may soon run into repayment issues. "A line of credit is a short-term bridge rather than a long-term fix," says Matt Schulz, chief credit analyst at the Lending tree. "It is meant to provide a consistent access to funds to help businesses push through short-term crunches, such as waiting for a client to pay an invoice or seasonal dry periods." Always err on the side of caution when determining whether or not to use a business line of credit for a particular expense. To be safe, you want to keep borrowing capacity intact. However, if a safety net is in place for the type of expenditures, you can then go ahead and borrow.
Here are five cases in which you might wish to use your business line of credit:
1. Unexpected disasters
A business line of credit can help your company respond promptly in the event of an emergency. For instance, a business line of credit can help you out in a case of a natural occurrence that results in property damage or complete failure of critical equipment which needs immediate attention.
However, it's wise to plan ahead of time for how you'll pay off the enormous debt as soon as possible, as it enables you to reclaim your borrowing power and reinstate your LOC safety net if something unexpected arises. In the case of a natural disaster, you may be eligible to receive insurance funds to repay the LOC.
2. Repairs of equipment
An SBA equipment loans ideal for use in the case of a simple equipment repair. It is best to limit your repairs to those that are both economical and rapid. It ensures that you don't use up too much of your business credit limit. As a result, it's better to use a company loan to finance substantial, non-emergency repairs or the acquisition of new equipment."If you're talking about completely new equipment, a business line of credit might not be the ideal fit," says Shulz. "Tying up funds from a line of credit in a large equipment purchase means there will be less available to use as a safety net in the event of cash-flow problems or other short-term financial problems."
3. Increasing the intensity
Using a LOC to assist you to pay for certain vital expenses while you're ramping up your business can be a good idea if you're confident enough in your performance that you'll be able to repay the business line of credit when your revenue increases in the future. Borrowing money from a business line of credit for startup of a business that you have little experience with is, however, a bad idea. Failure of the company doesn't spare you the repayment.
4. Seasons of high activity
Some firms have de facto or overtly seasonal busy seasons, which can be too much for the resources available at various times of the year. A business line of credit can assist you in covering all of the costs associated with operating at peak efficiency during the busy period, in the hopes that the increased sales earnings will allow for a rapid repayment once the higher sales levels subside.
"The additional funds from the line of credit can help you handle those unexpected expenses as you wait for the income to start flowing in during that busy period," Shulz adds. The goal is to ensure that you are confident that sales will flow quickly.
5. Pending payment
When you're waiting for payment from a customer, especially late payment, or when you're getting ready to take on a new and important client, a business line of credit can help. In both circumstances, you know the money will come your way, allowing you to repay whatever you borrowed as quickly as possible. Just be sure that if you borrow from a business line of credit as a down payment, you are confident that the money will arrive shortly. If you use your LOC only to have your client default on a payment you expected, you could find yourself in hot trouble.
GET AN LOC EVEN BEFORE YOU NEED IT
You should ideally have a business line of credit in place even before you need funds. If the private lender for business startup loans charges closing costs, establishing a business LOC may necessitate an initial outlay. As a result, to put one up before you feel compelled to may be difficult. However, the added security is definitely worth the initial investment. "It can be smart to get that line of credit before you need it," says Shulz. Keep in mind that you don't have to utilize it right away, and only the amount you use attracts interest.
Of course, as you may know, there are many benefits to having a business credit card. You can earn rewards or points that you can use toward travel and other purchases, you get special pricing on products and services that your company might need and more.
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