How to Advise Your Clients About Business Lines of Credit

Most small business are familiar with the concept of a revolving line of credit, either within a business or personal context (think credit cards). However, there are many different kinds of business lines of credit, and different costs and benefits for each one. In this piece, we’ll review the main benefits of a line of credit (LOC), the different flavors of LOCs available, and the pros and cons of each, so that you are well-positioned to advise your clients on their options.

Benefits of LOCs

For a small business, the main benefit of a line of credit is flexible and convenient access to funds for working capital purposes. Companies with a line of credit can tap into the cash as needed, without having to reapply for a loan each time. As the funds are repaid, they can continue tapping into the line of credit. The funds can be used in part or full, and can usually be paid back in installments or as a lump sum. For this reason, a business line of credit is frequently used for working capital purposes, such as payroll, supplies, inventory, meeting unexpected expenses, or expanding marketing and promotions.

Bank LOCs

Benefits: Lowest rates of any line of credit provider.

Cons: Long and tedious application process. Low approval rates.

Tip: Get your documentation ready in advance.

A bank line of credit is where small businesses typically go when they need a ready source of working capital. This makes sense because banks offer a multitude of products, and typically have existing relationships with business owners on the consumer side. This makes it an obvious choice for business owners who are looking for working capital to run their business.

But, there’s a catch … because banks are so heavily regulated and need to maintain certain portfolio characteristics, they have lengthy loan applications and high rejection rates (they decline about 80% of applicants). Many small businesses are also scared off from even attempting an application, when they learn about the mountain of paper work or stringent requirements that banks typically command.

Online LOCs

Benefits: Simple application, fast decision, easier qualification and speedy access to funds.

Cons: More expensive than a bank LOC.

Tip: Be wary of companies that either front-load the costs or have high APRs.

With small businesses desperate for options and banks hunkering down with the fallout of the financial crises, credit dried up for small businesses that needed it most. Recently, a slew of new technology driven lenders cropped up, ready to offer small businesses access to cash without all the hoops and barriers faced from a traditional bank. In place of a 10-page application, a clunky interface and a 5-week application process, they typically ask for some basic information via a clean online process, and respond within 24-48 hours.

The flip side of the ease, speed, accessibility and convenience is that these lenders typically charge higher rates than banks. The rates vary broadly, but APRs of 20-80% are typical, while rates over 100% APR are not unheard of. While these solutions can be a godsend for small businesses, they should be vetted to make sure that the terms and rates are within reason of what the small business can support.

Factoring Credit Line

Benefits: Businesses can qualify based on their credit, or based on the credit worthiness of their clients. Businesses cannot “borrow” more than they can afford.

Cons: Must have current B2B invoices. They have a “credit line,” but not a true “revolving line of credit.”

Tip: A convenient option if you want to be able to offer longer payment terms to your clients, yet still need the cash on your terms.

Invoice factoring is not true line of credit, strictly speaking, but can be useful and function like a line of credit, if the business routinely has unpaid invoices and long payment cycles. Invoice factoring allows a company “sell” or “advance” their invoices in exchange for a small fee. The fee varies, but it’s typically anywhere from 1-5% of the invoice. Annualized, the APR ends up being higher than that of a typical bank. Still, for many businesses, it’s the difference between getting the cash they need to maintain their growth and increasing their profits, as opposed to waiting 90 days for mega-corporation to pay their $50,000 invoice. On the other hand, invoice factoring is only relevant for B2B companies, so it is not an option for retail businesses or other B2C companies.

One of the major advantages of factoring is that it allows small businesses to qualify, based on their credit worthiness or the credit worthiness of their clients. In all, it’s an option that B2B companies should consider, alongside either a revolving line of credit or as a substitute for a line of credit.