If your business is just getting off the ground or needs a little help handling expenses, a business line of credit might be an appealing financial option. Business lines of credit work similarly to personal credit cards: a lender gives your business a maximum monthly limit and you can draw funds from that amount to pay your expenses. Of course, your company will be expected to pay off this credit debt or pay fees or interest on the loan.
The question is, would establishing a business line of credit be the right choice for your business? Consider these pros and cons to determine the best course of action for your company.
Pro: Flexibility. Perhaps the clearest advantage of using a business line of credit is that it offers spending flexibility for your business—and in several different ways. First of all, when you can pay expenses with your line of credit, you can cover payments even when you don’t have cash immediately on hand. Secondly, a business line of credit essentially acts as a bank loan where you have access to a large loan amount but don’t necessarily have to spend all of it. Instead, you can just draw money from the credit line as needed. You will only have to pay interest and fees on the money you actually use, but the rest of the loan will still be there in case you need it. As a result, business lines of credit usually cost companies less in interest payments than traditional lump sum loans.
Con: Risk. As with any form of loan, one of the biggest cons of establishing a business line of credit is risk. When you access funds from your line of credit—even if you are only accessing a small amount of money—you are essentially putting your business into debt. This issue can be a bigger problem for some businesses than others. If you aren’t great with managing money or have personal credit card debt, or if your business is in the “spend money to make money” stage, you could end up drawing more against your credit line than you can afford to pay down. Even if your company goes out of business, that debt is still there and you could be liable to cover the loan plus interest.
Pro: Maintaining Equity. When it comes to finding working capital for a small business—particularly a new startup—there are three basic options. You can funnel your own money into the project, which you have probably already done. You can go through a bank or lender to get the money, as with a loan or a business line of credit. Or you can bring investors on board, getting your capital money in exchange for business equity. Establishing a line of credit is an attractive option for many small businesses because it allows them to pay off expenses without having to sacrifice major equity stakes.
Con: Getting Approved. Most banks and traditional lenders are notoriously cagey when it comes to approving loans for small or mid-sized businesses—especially entrepreneurial ventures without much to show for a track record. As a result, you might struggle to get approved for a business line of credit. There are funding companies out there that are more flexible when it comes to lending money to small businesses and startups.
A business line of credit is not the “be all, end all” when it comes to securing an uninterrupted stream of capital for your company. However, a credit line can be a good way to handle operational expenses and keep your business running smoothly. So long as you keep the disadvantages of this lending model in mind and take care to avoid them, a business line of credit can save you from constant worries about money and give you more time to think about company growth and ideas.
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