Understanding Business Lines of Credit

Business lines of credit have become very popular over the last few years. Previously lines of credit were lending options from the big banks and SBA. But now alternative lenders have entered the market and with their entry, they have loosened qualification standards. They have eased up on credit and financial qualifications. 

Let’s start by discussing what a business(commercial) line of credit is and how it is used. A Business line of credit is a financing solution that allows the business owner to keep available funds at their fingertips. They can request any available amount and get the funds they need when they need it. As you pay back the borrowed funds the money becomes available again for reuse. And this procedure will continue for the agreed term of the credit line. Many say that it operates like a conventional credit card, which is partly true but there are some variants that you will be able to resolve through this article.

The one biggest difference from the comparison to a credit card is that many lenders and banks will put a term limit on the line where they want the advances to cease and the line paid off. Once the line is paid off the lender will require updated information to re-establish a new line of credit.

Types

First is the secured line of credit where a business owner can use personal and corporate collateral as an asset to secure repayment if they should default. 

The second is the unsecured line. But this is not what it sounds like. Many lenders’ sales agents use this term to dupe the business owner into thinking that if they were to default that nothing bad will happen, maybe a ding on his credit. These unsecured lines are often personally guaranteed by the owner or the company, which will allow the lender to come after the owner personally or after the assets of the business.

 

Alternative Lenders

As we discussed earlier, alternative lenders have started appearing in the market offering alternative style business lines of credit. The qualification requirements have been eased but this has been reflected in tighter term restrictions.  

These can be considered starter lines of credit which provides another option for small business owners who do not have the qualifications needed to obtain a standard business line of credit. This can be considered to be like a bridge loan, where this is the intermediary financing option while you prepare for more optimal financing. This will also help the small business build a track record that will help for future financing. Again a starter program.

 

The National and Local Banks

Today it is hard to find a local bank that is dedicated to the success of their community. These local banks are on the decline, but can still be found in some rural areas. They are more likely to work with small businesses throughout their community and may have flexible underwriting guidelines compared to that of the national banks.

But if you don’t have the luxury of living in an area that has a small local bank, then most likely you will not have success with the big bank unless you are a larger business. The fact is that most small community-based businesses have less than 15 employees, and this is where the problem exists. Those small community businesses do not whet the appetite of the big banks who are driven by large profits.

 

SBA (Small Business Administration)

If the small business has established itself as a viable entity for funding then they may have the ability to walk into their bank and possibly obtain funding, and yes I said possibly. Again depending on the size of the small business and how valuable the bank regards that small business, the process may drag on for months and in the end, it still may be declined. Many banks use board members to make the final decision on all financing transactions, and if they find that the small business is not worth the risk and that the profit that will be earned will not meet their minimum standards, they will decline the file.

Although the banks rely mostly on SBA for their business financing options, and even though SBA will insure that loan up 90%, the bank still has the final decision. SBA does not make the loan, which is a common misconception. What SBA does is act as an insurance policy to protect the approved lender from the consequences of loan default. As an insurer, SBA does utilize very strict guidelines that the lender must follow, and one of these guidelines may ask the borrower to pledge assets to protect SBA and the lender. It must only be understood that if the business does not have positive tax returns it is not getting approved

 

Qualifying 

Like we discussed earlier if the business is not up to par on their financials and other points that go into qualifying for prime financing, the business will have to alter course and try alternative lenders. Alternative lenders will still base it on personal credit score and the activity in the business bank account, but they provide the additional options some small businesses need.

Every business owner must strive to focus on the development of the business, and that means all areas. The back end will complement the front end and allow for faster growth. Only 30% of all small businesses utilize an accounting service and this is most likely the biggest contributor to 60% of all new ventures failing within the first 5 years. A small business owner may save a few tax dollars but will spend more on financing charges, suffer credit restrictions and stunt the growth of their business without the right back-office support.. A proper accounting system that is focused on growth will increase profits and increase the income of all owners.

 

Now let’s look at some of what underwriters for prime financing look at…..

 

Background and Credit Check – Business and Personal Credit Check along with criminal background checks

  1. The Financials – Business financials- must show the ability to pay
  2. Formulas, Ratios….it’s all in the numbers- qualifying formulas for loan amount and affordability
  3. Guarantee – Personal and/or Business Guarantee

Congratulations! You have met all the conditions of the underwriting process and you have been approved for funding. The last step in the process is to understand the closing documents and any restrictions or covenants that they include. This is where you will understand how to maintain the line of credit in good standing and the reasons they may restrict or cease the use of the line. 

Access to cash flow is important to a small business. It keeps the business whole and keeps it growing. But obtaining the right funding at the right terms, and the right funding amounts is the secret to a long and viable business life. We have discussed that there are many factors in running a business. It takes a uniform cohesion between the back end and the front end of that business to be sustainable. Yes, sales are important, but knowing how that cash flow is working for you is just important. Think of those history lessons that showed kings with massive stashes of gold and jewels just to lose it all. It was because they had a bad accounting system! The most famous was Caligula.

 

There are various routes for business financing, and you must understand the benefits of the options available to small businesses. Contact Ebizmore Accountants and Advisors (info@ebizmore.com) to learn financing options and why it is important to have a functional back end that enhances the work and focus of the front end.

If you want to learn more about starting a business in Commercial and Business Finance, Accounting, or residential mortgages contact as at info@ebizmore.com and provide contact info and interest and we will get you on your way to a very profitable career.

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