Wondering whether you should apply for a small business loan or a line of credit for your startup? Here are the main differences between the two:
- 1: Lines of credit typically are issued in smaller amounts than loans.
- 2: Lines of credit typically have higher interest rates than loans.
- 3: You don't receive the full amount of money up front, as you do with a loan, you draw on the line of credit when you make a purchase.
- 4: You don't have to specify up-front what you will use the line of credit for, as you often do with a loan.
- 5: Approval may be more difficult for a line of credit than a loan.
In general, you may want to apply for a business loan if you need a large amount of money in one lump sum to finance expansion, inventory, equipment or other significant expenditures. If you need to have extended, ready access to funds to manage short-term cash flow issues, or to finance activities such as a marketing campaign or seasonal hiring, a line of credit may be a better choice.
How does a small business qualify for a line of credit?
Qualifying for small business line of credit can be challenging. You're more likely to be approved if you have an excellent credit history, have been in business for at least two years, and can show that your business revenues are growing.
Here are the basic issues you'll need to consider:
1) Do I meet the minimum qualifications?
Minimum qualifications and conditions are set to ensure you're the right candidate for a line of credit. Candidates who exceed the requirements and minimum qualifications have the best chances of qualifying. In most instances, if you've had recent delinquencies or bankruptcies your chances of qualifying for a business line of credit will be slim to none. Lenders also look at annual revenue, number of years in business, and credit score among other criteria when qualifying an applicant for a business loan.
Bear in mind that business lines of credit are typically not extended to brand new start-ups, or to meet immediate operating expenses. They are intended to be used to grow your profits. If your business doesn't have a track record of success, you may need to apply for a personal line of credit (assuming you have an excellent credit history).
2) Do I have enough collateral?
If you have an excellent credit history, you may qualify for an unsecured business line of credit. Otherwise, you should look for a secured business line of credit which requires you to pledge assets as collateral to secure the loan. Lenders will prefer assets that can be liquidated quickly, such as accounts receivable and inventory. If you default on your payments, the lender can assume ownership over the pledged assets to recoup their money.
3) Do I have the right documentation?
Most traditional lenders require legal and financial documentation. Gathering the appropriate paperwork can be time-consuming and challenging for many small business owners. Some of the documentation you will need typically includes: Commercial Leases, government-issued ID, your business license/articles of incorporation, several years of income tax returns (potentially personal and business), and a business plan. You'll also probably need to produce a three-year projection of business revenues and expenses, and information showing how the line of credit will be used to drive profits for your business. You might also be asked to provide detailed information about your accounts receivable, inventory and all other financial liabilities. But check with a potential lender first to find out exactly what you'll need.
What are the fees for a line of credit?
Fees vary by lender, and are based on your credit history, the collateral your pledged, and the lenders servicing charges for transactions. You will probably pay an annual fee as well, along with interest on the amount of money you are using at any given time.
Alternative funding for your business
A line of credit may be exactly what you need to expand your small business. But lines of credit aren't the only option to fund your business. One Park Financial has a network of funding sources that offer more flexible approval terms than traditional lines of credit. Applying is painless and easy, and our team of professionals will be more than happy to help you find the right alternative funding option for your business. Visit oneparkfinancial.com to learn more and prequalify for funding.