Unlike other loans, it offers repeated access to funds—enabling you to make charges and pay off your balance as needed. This comes in handy when you need to manage cash flow gaps, invest in inventory, or seize unexpected growth opportunities. Let’s take a look at how business lines of credit work and whether they're a right fit for your company.
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What Is a Business Line of Credit?
There are various financing options available to small businesses that need extra funds. Here's a quick overview:
Business line of credit: Similar to a credit card; you have access to a revolving line of credit. This means you can repeatedly borrow up to a certain limit, repay it, and borrow again. You'll only pay interest on the amount you actually use.
Business loans: A fixed amount of funds is disbursed to your account, which you repay according to a predetermined schedule.
Business credit cards: Similar to personal credit cards, these offer a credit limit that your business can use for purchases. You need to make at least the minimum payment each month, and interest will be charged on any balance that carries over to the next billing cycle.
Why Consider a Business Line of Credit?
With so many financing options available, why opt for a business line of credit over a loan or a credit card? Here are some compelling reasons:
A line of credit provides quick access to funding whenever you need it.
Lines of credit may often offer lower interest rates than credit cards.
You can reuse a line of credit as many times as you need.
You only pay interest on the actual amount you borrow.
A business line of credit can be unsecured (you don’t need to offer up anything as collateral), or secured if you prefer to provide collateral.
Note that you don’t necessarily need to have a huge or established business to get a business line of credit. For example, the U.S. Small Business Administration (SBA) introduced the 7(a) Working Capital Pilot (WCP) Program in June, which is designed to help small businesses access the funding needed to expand their operations.
Administrator Isabel Casillas Guzman, head of the SBA, emphasized the importance of competitively-priced lines of credit for small businesses to operate effectively and seize growth opportunities. She noted that the SBA has introduced the 7(a) Working Capital Pilot Program to address market demands, particularly in the current high-interest-rate climate.
How Does a Business Line of Credit Work?
In order to get a business line of credit, you’ll first need to apply through a bank or lending institution. Depending on the lender, there might be different requirements for the provided documentation. Generally speaking, however, you’ll need the following:
Business line of credit application
Business tax returns for the last two years
Business plans
Personal tax returns for the last two years
Financial statements, including your balance sheet, profit and loss, A/R AP Aging Report and Debt Schedule
Personal Financial Statements
Proof of collateral (if secured)
Personal guarantee
Personal credit check
Once your documentation is in order and your application is submitted, your bank will evaluate it to determine your credit limit and interest rate. This typically depends on your business’s financial history. Generally, more established businesses might access higher credit limits with lower interest rates, while newer businesses might find they are offered smaller credit limits with higher interest rates.
Your rates and credit limits will also be affected by whether it’s a secured or unsecured loan. Secured lines of credit often come with lower interest rates since they are backed by collateral and provide less risk to the lender. Unsecured lines, while more flexible, typically carry higher interest rates due to the increased risk to the lender.
After approval, the funds from your line of credit are available immediately. You can transfer these funds to your bank account or use a line of credit card to make direct purchases, much like you would with a debit card.
What Are the Pros of a Business Line of Credit?
There are many good aspects to opening a line of credit:
You don’t pay interest on the entire line of credit, only on the purchases you make
A business line of credit is revolving, meaning you can access the funds more than once
You only have to go through the approval process one time
Interest rates are lower than using a credit card
It typically offers a higher limit than you get with a credit card
What Are the Cons of a Business Line of Credit?
It starts accruing interest the day you make the charge
You don’t earn rewards like with a business credit card
The limit is determined by your credit provider
The credit provider may require you to provide collateral
Who Should Consider a Business Line of Credit?
While a business line of credit is not a one-size-fits-all solution, it can be incredibly beneficial for certain types of businesses. If you often find yourself needing swift access to cash to bridge gaps between revenue receipts, a line of credit could be the ideal financial tool for you.
This type of financing is particularly suited to businesses that require funds on a short-term basis. Since it only begins to accrue credit on the day your charges are made, you could pay back the drawn amount quickly and effectively manage the timing of your borrowing to minimize interest costs.
How to Qualify for a Business Line of Credit
The criteria for obtaining a business line of credit can vary significantly between lenders. These requirements will also depend on whether or not your business line of credit is secured or unsecured. Unsecured lines of credit are more risky and so will usually have more strict criteria for approval.
While many lenders may have a lower bar for entry, here are some general requirements for a business line of credit approval:
Duration of operation: Your business should typically have been operational for at least two years.
Revenue requirements: You might need to maintain a minimum of $100,000 in annual revenue.
Credit health: A good personal credit score is crucial as it reflects your reliability in managing debt.
Business planning: A well-articulated business plan that outlines your business's goals and methods for achieving them.
Personal guarantee: Often, you'll need to provide a personal guarantee, which commits you to repay the loan if your business cannot.
Business Line of Credit vs. Business Loan: Which Is Better?
Although both business lines of credit and business loans give you access to funds, their target demographic differs.
Business loans are good if you need a one-time, large lump sum of funds. Since loan repayment terms are fixed, you’ll need to make specific payments each month. You should also be aware that some loans can charge you penalties if you pay off your debt early.
Business loans can have either fixed or variable rates. Generally, business loans will have lower interest rates than business lines of credit, so if you anticipate needing time to pay off your debt, a business loan may be a better option.
Business lines of credit, however, may be a better fit if you need money to grow or cover payments for your business but anticipate repaying your line of credit quickly. Although it charges more interest than a business loan, it’s also reusable. When you need access to credit again, you won’t need to reapply and be approved again, like you would for a business loan.
Alternatives to a Business Line of Credit
Business loans and business credit cards are the main alternatives to a business line of credit. While we’ve already discussed the use cases of business loans, there are some unique situations when a business credit card can be a good fit.
Business credit cards tend to charge more in interest than business lines of credit, so they aren’t suitable for those who plan to carry a balance. That being said, they can compete with—or even complement—a business line of credit.
If you don’t need large sums of money, the credit limit on a credit card may be sufficient for your needs. And because credit cards don’t accrue interest unless you fail to pay your balance in full, you could save money on the interest that you wouldn’t be able to with a business line of credit.
Aside from this, using the right business credit cards can be incredibly rewarding. Some reward credit cards, for example, earn 2x miles on every purchase. These rewards can then be redeemed for travel, gift cards, cash back, and other perks.
If you have both a business line of credit and a business credit card, you can use them in conjunction by making purchases on a business credit card and using the business line of credit to pay off the card. In this way, you can utilize the lower interest rate of the line of credit while still earning rewards on the credit card.
Bottom Line
Business lines of credit help business owners grow by giving them access to funds they wouldn’t otherwise have. They’re especially helpful if you need to reuse your credit periodically without waiting for approval (like you would with a business loan). However, you might need at least two years of operations and a minimum annual revenue to qualify for a line of credit—though some credit providers have special offers that waive these requirements.
