When it comes to financial instruments, lines of credit are often the most misunderstood. However, lines of credit have many advantages every startup owner or seasoned entrepreneur should consider. In this article, we’re going to touch on how lines of credit work, if you can qualify for one, their pros and cons and other options that may be at your disposition.
The Truth about Lines of Credit
There is one pervasive myth floating around financing and that is that most banks will issue a line of credit to any business with a solid business plan. This myth has been perpetuated for many years, often with the story of a gutsy entrepreneur who was able to get a loan simply through the power of persuasion and gusto.
However, things do not happen like this in the real world. No reputable financial institution will offer a business a line of credit simply out of good faith. This doesn’t mean that financing is impossible for startup businesses. However, small business owners will have to be prepared to meet some really stringent requirements in order to be accepted.
The Ins and Outs of Lines of Credit
In a nutshell, a line of credit is a financial instrument that allows people to withdraw a certain amount of funds up to a predetermined amount. You will be required to pay charges on any outstanding balance and make payments to reduce it. Lines of credit are, in many ways, similar to cash advances on credit cards, but are slightly different.
What makes lines of credit so popular is how flexible they are. Lines of credit can be used to pay suppliers or deal with cash flow issues. They can also be used to cover operating expenses. However, lines of credit aren’t recommended when comes the time to make huge expenses, such as machinery for instance, and loans would be more suitable in these cases.
Lines of Credit aren’t as Easy to Get as You May Think
While companies like BlueVine specialize in getting business lines of credit to startup owners, getting a line of credit for new businesses isn’t always easy. For any bank, lending money has a significant amount of risk, and banks understandingly have their sets of requirements every applicant should meet to be eligible.
But usually, it comes down to three simple things: cash flow, credit and collateral. And when it comes to lines of credit, applicants will usually need all three to qualify for one. Usually, lenders will use the credit score as a sign that the business can be trusted and will ensure that the business has enough cash flow to repay the line of credit. In addition, most lenders will ask that the business owner has significant collateral to cover the line of credit.
In many cases, lenders will only extend a business line of credit to businesses who have been in operation for a minimum of 2 years. And this is what stops many new entrepreneurs from qualifying for one, lack of operating history. Also, maintaining a line of credit isn’t a simple affair either, with banks routinely changing the terms and adding covenants to the loan that applicants need to adhere to.
Alternatives for Small Business Owners
In some cases, business owners can qualify for a personal line of credit that they can use to finance their business. These owners usually have strong personal credit or significant assets that they can use as a collateral to cover for the line of credit. For instance, if the business owner has a home, they can apply for a home equity line of credit that they can use to cover for expenses. Also, unsecured line of credits are available to people with strong credit scores who don’t have assets to pledge as a collateral.
Lines of credit, while having their fair share of advantages, aren’t perfect and aren’t as magical a solution as many people may think. Most require that you meet specific requirements and obligations. Also, in some cases, lenders will only allow you to increase your line of credit after a set period of time, even if your needs increase.
However, lines of credits are great for entrepreneurs with limited financing options that want to cover for minor expenditures without resorting to a traditional bank loan. With more and more lenders catering to startups and small business owners, lines of credit are easier to obtain than ever. So if you think a line of credit is the right choice for you, make sure to look around and see if you can find a lender that can understand your needs.