When operating a small business, you need to be prepared for all kinds of unexpected situations. For example, perhaps your building gets flooded—you may need to pay for plumbing repairs and replace some crucial equipment. On the other hand, the unanticipated need for money could be due to the emergence of an opportunity you want to take advantage of, but you need some cash upfront. Whether the reason is to address a problem or respond to a fortunate occurrence, having access to a little extra funding will be handy. 

What is a business line of credit?

A business line of credit is like a loan, but sometimes better. A line of credit allows you to meet unexpected financial needs without obligating yourself to significant payments. For example, suppose you obtain a line of credit with a limit of $150,000. If you don’t use any of the money, you don’t need to make payments. If you only use a small amount, your payments are based on how much you use. Even better, when you repay what you used, it is available for re-use if necessary. 

Let’s consider an illustration:

You obtain a $150,000 line of credit for your business. One month, you experience a cash flow issue and need to use $10,000 from the line to meet payroll. All is well, and you begin making payments on the amount you used. Then, suppose you learn about the opportunity to expand into a bigger location in a few more months, and you need $40,000 to finance the lease and pay for the move. Now the payments are bigger because you have used more of the available funding.

But you still have a cushion of $100,000 for other needs if they arise. And after you pay back part of the $50,000 you have spent, that gets added back into the available credit line.

Where can I get a line of credit for my small business?

Many financial institutions like banks, credit unions, and online banks offer lines of credit for businesses. Start by talking to a lending officer at the bank you use for your business checking and other financial services, but don’t assume they will offer you the best rate. They might not, even though they know you. Various banks and other lenders set product terms based on their preferred products. That means if a particular institution is concerned about the risks of car loans, for example, they might offer a slightly higher interest rate for car loans than a competitor. If that same bank has more confidence in housing, they might set their mortgage rates at a more favorable level. That’s why it may pay to shop around and consider using a loan broker to compare options.

What do I need to know before I start?

When you start the process, one of the first things you need to consider is whether you are looking for secured or unsecured credit. Secured credit means you provide collateral to the lender, which gives them recourse to recover their money if you default on the loan. For example, you secure a home mortgage using the property, which is why it’s difficult to obtain a mortgage for more than a property’s appraised value. Likewise, vehicles can be used as collateral for personal car loans. Other personal loans and most credit card debt is unsecured, which means the lender has to collect from you; they can’t sell the furniture you bought using your Visa. 

A business line of credit can be secured or unsecured. If you apply for a secured line, you will need to offer collateral plus all the other financial information the lender requests to consider your application. Typically, the lender needs your personal credit information, although that depends on the size and longevity of your business. In addition, you will need to provide details about your company’s revenue and how reliably you pay your bills. 

To obtain a secured line of credit, you must provide collateral to support the loan amount. If you own the property your business occupies, that is one good source of collateral, as is an expensive piece of equipment (as long as you own it, but not if you are still making payments toward the price.) The upside of a secured line is that typically the lender can offer a lower interest rate and less expensive fees since their risk is less than it would be with an unsecured line of credit. 

What documents will I need?

As with many situations where you are applying for credit, the documentation required for a business line of credit can seem extensive. Prepare for the lender to ask for many of these items:

• Business and personal tax returns
• Business license and documents outlining the structure and ownership
• Profit and loss statements
• Financial statements and general ledger
• Business plan
• Building lease or mortgage information

You should also be prepared to specify the amount of credit you want. Remember that the better your company and personal credit score, the more likely you will get approved and receive a favorable interest rate. While proceeding through the application process, be responsive to your prospective lender’s requests for additional information or clarification. Promptly providing requested information shows you are reliable and serious and could positively affect your chances for approval. 

How large should my line of credit be?

Unlike a traditional business loan, your line of credit usually isn’t designated for a specific purpose. You don’t have to tell the lender what you intend to do (even if you know.) You may want to have it available in case of emergency, for peace of mind to protect against an income interruption, or to access when a great opportunity presents itself. The great thing about the line of credit is that you only make payments if you borrow against it, and your payment varies according to how much of the line you have used. If you don’t need it, you aren’t paying for it.

With that in mind, requesting a little more than you think you need may be a good idea. Just remember not to be careless about spending. Like a personal credit card or other lines of credit, spending more than you intend is easy. So be cautious, and you can ensure that you have the funding you need when the time arises.