Small businesses, especially start-ups, often suffer from gaps in their working capital. New companies often do not have the cash to stay afloat between buying inventory and collecting on their first cycles of accounts receivable. Business lines of credit can be a helpful way to cover that shortfall in the short term.
A line of credit is a loan that works similar to a credit card—the bank sets a limit for the borrower, and the entrepreneur can borrow up to that limit during a specified time period, usually about a year, only making payments on the interest. After that, the borrower must start repaying the loan. Sometimes a bank will require a borrower to pay down a portion of the loan earlier if the payments are not made on time.
For start-ups and young companies, local banks and credit unions are often the best places for obtaining business lines of credit. Some local lenders even specialize in small business loans and are looking for potential borrowers.
Before applying for a business line of credit, banks need to take care of some basic prep work:
- Obtain an Employer Identification Number for the business to make it a legal company, separate from the owner’s personal finances.
- Register the firm with the state. Many lenders may require proof of business registration before making a deal.
- Prepare to show how the loan will be repaid. There should be a primary and secondary source as lenders want to know you have a plan for paying back their money. If the primary and secondary sources do not seem adequate to the banks, they may require the owner to put up some personal collateral, like a home or other large asset.
- Collect important financial statements like cash flow statements, balance sheets and income statements. These will hopefully help banks see that the owner is managing the business well and that the company is on track to profitability.
Once these steps are taken, all that is left is to fill out the applications. Business lines of credit can sometimes be approved within a few weeks and the line can be available immediately after approval.