Running your own startup certainly comes with many benefits, but it also has its own unique set of problems you won’t run into elsewhere. For instance, especially within the first couple of months or years, you will often find that your startup or small business is struggling one month, and then killing it the next.
While there are multiple reasons for that, one of the most common problems such companies face is maintaining a steady cash flow. As a result of this, as much as 20% of all SMEs shut down their doors forever.
However, startups and stability don’t have to exclude one another since there are plenty of financial products you can turn to to keep your cash flow at a steady level, ranging from business credit cards to loans. But, there is one other option that you may want to consider, and that’s getting a business line of credit for your startup. We have put together a short overview to make things more transparent to see how it works, what it is, and why it may be a better option than loans or credit cards. Keep on reading.
What Is a Line of Credit?
A line of credit allows you to withdraw funds from a predetermined amount. One of the advantages of opting for a line of credit, as opposed to some other financial product, is that you get to pick how much cash you will withdraw because you’ll only pay interest for the amount you have removed. This means potentially lower interest rates, which means that a line of credit can be cheaper than using credit cards.
Whereas short-term loans might be helpful in your startup, in case you need more cash, you have to apply again, which can take a long time. On the other hand, your line of credit can be replenished provided that you have repaid the sum you have borrowed. For example, if your startup has been approved for a line of credit of $100,000, and you decide to withdraw $20,000, there will be $80,000 left. Once you return the $20K you have borrowed, your credit line will go back to $100,000.
That will allow you to bridge gaps in your cash flow relatively quickly, pay for operational costs of your company or inventory, as well as to fund your company’s payroll. According to statistics, 47% of small businesses use a line of credit to fund their day-to-day operations. As far as the numbers are concerned, you can usually get a line of credit of $10,000 to upwards of one million dollars, depending on your business’ revenue, credit history, cash flow, and so on.
How and Where Can You Get a Line of Credit?
In most cases, to get approved for a line of credit, you need to go to a bank or an online lender. Keep in mind that there are numerous conditions you need to meet in order to get approved. First, you need to have a good credit history as an owner. Second, your startup needs to have a sufficient cash flow, which indicates that the company can repay the line of credit. Finally, you will need to put up something as collateral to get approved.
What You Need to Look Out For
Similar to all other financial products, a line of credit is not without its pitfalls. As we have pointed out previously, you may have trouble qualifying if your startup is relatively new. Banks may also require you to bring other businesses with them since credit lines are less profitable for banks when compared to loans or credit cards. Also, if you want to expand your company, make large investments, get a new office space, or invest in machinery, credit lines are not the best option, considering that they are meant to be used for smaller amounts.
While they are cheaper regarding interest rates, credit lines also come with their own fees, usually paid upfront. This applies to one-time payments when getting approved and maintenance and withdrawal fees, which don’t exist for loans and business credit cards. Another downside is that a line of credit is still a form of debt, which can land you in trouble, just like any other type of loan. It’s not uncommon for new startups to find themselves in a situation where they have spent all of the funds in their line of credit, yet they are not generating enough profit to repay their debt.
That is why you need to make sure that your cash flow is sufficient by collecting your accounts receivable on time, and/or to request advanced payment from your customers. One last thing: you will come across terms like “secured” and “unsecured” lines. For tight lines, you need to provide assets as collateral. In the case of unsecured lines, you need to provide a personal guarantee to the owner, and you can only get that if you have an excellent credit history. Also, if your company goes bust, the bank can go after your personal assets.
As you can see, getting a line of credit comes with numerous pros and cons. If used properly, a line of credit can help your business flourish, and you can even use it to finance other financial products, such as loans. Good luck!
Ready to learn more about financing your small business? Building credit for your business is a great way to go.