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Why, When, and How to Open a Line of Credit for Your Small Business

You want to start a business now, but you don’t have enough cash saved yet. Or maybe, your small business is starting to flag, and an injection of money is all you need to get back on track. Or maybe nothing is going wrong with your business ― you just want the opportunity to get the funding you need exactly when you need it.

In all of these situations, you might consider opening a business line of credit. Banks and other financial institutions offer lines of credit to small businesses that function similar to a personal credit card, and most entrepreneurs find such funding opportunities highly advantageous.

However, before you start opening lines of credit for your business, you should understand why they work, when they are beneficial, and how you go about getting one.

Why Businesses Need Lines of Credit

There are dozens of ways businesses can obtain funding ― besides the most obvious one of selling products and services. For example, you can acquire a small business loan, seek partnerships with venture capitalists or angel investors, or ask friends and family for some fast cash. However, few of these methods are feasible for a business that needs a small, regular monetary infusion to sustain growth. Enter: the business line of credit.

Many lenders liken lines of credit to loans, but in truth, the similarities are few. Loans tend to be substantial; you are unlikely to find a lender interested in providing less than $100,000, unless you acquire a microloan from a non-profit organization, and the average small business loan size is roughly $371,000.

Such an enormous sum is truly only useful when businesses are just starting or planning a major expansion, since you will be paying off that loan for years to come. If you just need a few hundred bucks to balance your cash flow, a loan isn’t the right option.

Meanwhile, you decide the amount of cash you borrow through your line of credit, and that amount might vary from month to month. The interest rate is relatively low and can fluctuate with the market, and your balance will change depending on how much of your credit you utilize every month.

However, because you retain control of how much you borrow, you should be able to pay off your credit balance without issue, surmounting cash flow problems and maintaining strong finances no matter your business tribulations.

When Opening a Line of Credit Is Worthwhile

It is advantageous to have a line of credit available, even if you only use it when a need arises. Your need for credit will depend on your business and your goals, but most importantly, you should try to draw upon your line of credit only when you have small, short-term cash needs.

Here are a few common scenarios when using a line of credit is preferable to seeking other forms of funding:

  • When crucial equipment breaks down and you need to replace it before you can earn more income
  • When you want to begin a new marketing campaign or sustain an existing one
  • When your current place of business is in desperate need of remodeling
  • When an increase in your product’s demand is imminent and you need to acquire more inventory fast
  • When your business is seasonal and you need to offset temporary lows

As long as you aren’t using your line of credit to replace income for an extended period of time, you will find that using credit is a healthy and strategic business practice.

How to Find the Right Line of Credit for Your Business

Your interest rate and credit limit are determined by a handful of factors: your credit history, your existing cash flow, your business’s age, your hart assets and short-term assets, and your lender. Before you apply for a line of credit, you should perform some research, so you won’t be blindsided by extraordinarily high interest rates or untenably low limits.

If your credit score is lower than 600, if your business is younger than 6 months, or if you lack revenue information for at least the past three months, you need to spend time organizing your business before any lender will be willing to work with you.

When your business and personal paperwork is in line, you should look into possible lenders, comparing interest rates and other terms to ensure you get the best deal for your business. As with any funding, a poorly managed line of credit can sink your business ― or it can help it soar, which means you must be careful to get the right credit from the beginning.

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