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Many small business owners apply for a business line of credit as a way of funding the business. A line of credit (LOC) is a form of credit card that allows you to borrow/withdraw money up to a certain maximum amount from a financial institution. It gives small loans to small businesses to cover daily expenses. Before applying for a LOC, consider the following pros and cons to help you determine whether is good for your business or not.
1. Improves business adaptability: A LOC helps you to grab business opportunities within a limited time period. If your supplier cuts down costs significantly for a limited window, you may want to take the offer but don’t have enough cash. A line of credit will help you take advantage of the offer and save some money.
2. Boost your cash flow: Line of credit provides you with the cash needed to run the business during slow seasons or when in short of cash.
3. Flexibility: A LOC gives the flexibility to borrow a loan whenever needed. The money is borrowed in small amounts as long as you don’t exceed the limit.
4. Build business credit: Receiving a business line of credit and paying responsible will enable you to boost your credit score and maintain a good business credit history.
5. Pay for what you use: Interest is only paid on the amount used. You can also enter into an agreement with the lender on when to pay off the balance without incurring any prepayment penalty.
6. Low-interest rates: Compared to other forms of borrowing money, interest paid on money withdraw using LOC option is lower.
7. Simple: It makes the purchase of commercial equipment or other products much simple.
8. Control of business: Line of credit enables you to maintain control of the business. You don’t have to worry about investors taking control of the business or seeking funds from friends and families.
9. Suitable for small business: Line of credit is a suitable alternative to small businesses with low margins.
10. Variable payment: The payments on the line of credit vary and mostly depends on the outstanding balance.
1. Restrictions: A line of credit has some set limits on the maximum amount of loan you can obtain. If you need a huge amount of money, you should look from other funding methods.
2. Extra charges/fees: LOC uses pay-as-you-go format and if not careful, fees and extra charges may add up. The charges depend with terms of the agreement and with the lender. Do research and compare lenders additional fees before applying.
3. Misuse: It should only be used when facing cash flow shortage and using it more often may result in more problems.
4. Financial disaster: Failure to pay interest rates when due and staying within credit limit may result in financial disaster especially those who are poor in financial planning.
5. Risk: Applying for a line of credit puts your business at higher risk. If the business fails, you’re personally held liable for payment of the debt.
6. Difficult to qualify: You need to present two years of business history, financial statements, bank account information, personal and business tax returns, and other documents for you to qualify for a line of credit.
7. Cash infusion: Although LOC can create a cash infusion when money is tight in the business, you will have to repay the line of credit debt. Repaying this debt sometimes can be challenging.
8. Interest payment: The business has to pay interest on the money used from the line of credit.
9. Not available to pure startups: You must be in business for at least two years and have a profitable venture to qualify for a line of credit.
10. Expensive to maintain: You must comply with new covenants added to the loan by lenders. This makes it difficult to maintain the LOC active.