At some point, your small business may need to establish a line of credit. A line of credit can give your company the flexibility to advance funds, pay them back and then readvance throughout the term of the loan—similar to how a credit card works versus a car loan or mortgage loan.
This sort of working capital is great for paying seasonal expenses or financing a quick hike in your inventory, whereas a loan is used to purchase longer-term assets, such as a building, equipment or even a business acquisition. It’s important to work closely with your banker to help you decide which credit choice is best for your business.
KNOW WHAT TO EXPECT
When you meet with your banker to apply for a line of credit, ask if he or she can provide a checklist of what’s needed to assist with the decision-making process. You can increase your chance of success for approval and speed up the process by providing a complete packet of information.
Your banker should be willing to help you with any questions you might have. It’s also recommended that you come prepared for that meeting with queries of your own. Here are some example questions:
Does your bank offer SBA-guaranteed loans or lines of credit?
If the bank is a qualified U.S. Small Business Administration lender, it may approve a loan that might otherwise be turned down. The SBA guarantee provides the bank with an additional source of repayment on a percentage of the loan. Your request might not need an SBA guarantee, but it is good to know if it’s an option for you.
What kind of time frame should I expect? Tell me about your decision-making process.
Understand how your request will be processed. Each bank has a different procedure for underwriting and approving a loan depending on the bank’s size and appetite for credit risk. While one may utilize a loan committee, others might have a large individual lending authority.
What kinds of costs should I expect? What interest rates are available?
Don’t be surprised if a banker would prefer to underwrite the loan first before offering up interest rates. Pricing on a loan can be tied to risk, so depending on the financial strength and credit risk of the loan, the interest rate could be higher or lower. Examples of costs tied to a line of credit could be an origination fee or UCC filing fees to perfect the collateral. It’s always good to ask so you are prepared.
STRUCTURE AND COLLATERAL
Your banker is also likely to ask questions about what created your funding need and help you choose the correct structure. It might be that you would be better off with a term loan versus a line of credit. This will be based on your cash flow available to repay the debt, what kind of collateral you have to provide and the purpose of the funds.
Typical types of collateral for securing lines of credit are accounts receivable and nonperishable inventory. The bank will margin the collateral to account for potential loss in value. For example, if your accounts receivable are worth $100,000, the bank may assign an advance rate of 75 percent of that total, allowing a collateral value of $75,000. In addition to business assets, personal assets may also be required to support your request. Sometimes, personal assets allow the bank to be more flexible in terms of the loan structure and can even result in a better interest rate.
Your bank will also look at things like the overall financial strength of the business, whether it’s a startup or an established company, overall management experience and ability, and the owner’s personal credit history. Good personal credit history is especially important if you are a small-business owner. After all, you are the business.
