Understanding Business Lines of Credit

Whether it is to meet seasonal inventory demands, remodel your office space, or take care of any other short-term financial need, a line of credit is an excellent way to have extra funds available to your business when you need them. Not unlike a credit card, you pay interest on the outstanding monthly balance only.

Many new business owners use personal lines of credit in order to finance their companies when starting out. However, once the business has made it through the initial growth phase, it is advantageous to apply for a business line of credit. Such commercial lines of credit take the business owner out of the equation so that his or her personal credit rating is no longer affected by business transactions nor is he or she putting up personal assets as collateral. By forming a limited liability company, or LLC, and having an employer ID number, you can use company assets as collateral to open a business line of credit and separate your personal credit rating from that of your business.

While business lines of credit are often more difficult to obtain than personal lines of credit, once you have one you will leverage your buying and borrowing power. The key is to first build a strong business credit report. To do so, you need to first register your company with the business credit bureaus and make sure to follow their requirements closely. It is also imperative that all licenses, permits, and other such state and federal requirements are met. Next you want to establish credit with companies that you do business with. Once you establish credit with your suppliers, you must pay bills in full and on time. By not involving yourself personally in any such transactions, your business will build a separate credit status. Such trade credit then needs to be reported to the business credit bureaus, which include D&B, Business Credit USA, and the business divisions of Experian and Equifax.

A good business credit rating and a sound financial history showing that your business has been profitable (usually for 18 months to two years minimum) will often be enough to get you started. Many business owners use the bank that holds their personal accounts because they already have an established relationship. When seeking a line of credit, be prepared with financial documentation such as income statements and tax returns.

Lines of credit vary in how they are set up. For example, business lines of credit are typically asset-based, meaning hard assets are used as collateral. Such credit lines can also be based on receivables and in some cases inventory (although this is less common because the value of inventory can decline very quickly and is therefore seen as a greater risk to the lender). The interest rate can also differ because commercial rates may be equal to or exceed the prime lending rate (also based on the level of risk as perceived by the lender). Therefore it is advisable to shop around. While seeking such a line of credit, you will also want to know that the interest being paid is only on the money being borrowed, as opposed to being calculated on your borrowing limit or in any other manner. Also, inquire whether deposits are made directly to the outstanding balance, which reduces the amount of interest you will have to pay.

A revolving line of credit can allow you to always have the funding available that you need and give you peace of mind as a business owner.