What is a Business Line of Credit and How to Use it (and When!)

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The reality is that all businesses need to borrow money from time to time. Whether it’s a bank loan to help with the start up, or refinancing to help weather a storm, some carefully considered business borrowing can help entrepreneurs to realise their dreams. In this post we are going to take a look at what a business line of credit is and in particular, at unsecured business financing. We will examine classic unsecured lines of credit such as credit cards as well as credit card alternatives. In case these concepts are new to you, we will provide a line of credit’s definition in each case.

Let’s begin.

What is a Business Line of Credit?

Credit is quite simply the ability to borrow money with the intention of paying it back later. Lenders or creditors (be it a bank, credit card company or a loan shark) make an assessment of the borrower’s ability to repay and advance the funds accordingly. If the borrower defaults or fails to pay the monies back, then the creditor has varying different options open to it to enforce the debt.

Business credit is credit awarded to a business (be it an LLC or a Sole Trader) for the purposes of conducting its business. For example, a business credit card to cover petty expenditure is credit. A loan to buy a 2nd delivery truck is credit and a large scale refinancing exercise to acquire a competitor is credit.

Secured Vs Unsecured Line of Credit

A secured line of credit is one where the lender has some form of collateral, or security, for the money they advance, For example, a mortgage is a secured line of credit. If a business wanted a loan to buy a new truck, then the creditor could secure the loan against the truck and could repossess the truck should the borrower fail to repay the loan.

And conversely, unsecured credit has no collateral. If the borrower fails to repay the money then the creditor is at greater risk of making a loss.

Let’s take a closer look at some common forms of unsecured business credit.

Business Overdrafts

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An overdraft is possibly the most informal line of credit available and basically allows a bank account holder to spend more than it has in its account. When a business opens a bank account, the bank will offer an overdraft based on the business’s turnover and its credit rating.

Overdrafts are typically pretty limited and also tend to incur high fees and interest charges. Still, they can be useful when fast, short term credit is needed such as when an unexpected invoice comes in and needs paying.

Business Credit Cards

Credit cards are a very common form of personal credit and do have a place in business too. However, owing to the high interest charges, most businesses try to keep credit card use at a minimum using them mostly for petty expenditure (buying coffees for staff, gasoline or client hospitality) and try to avoid making large purchases on credit cards.

As indicated above, credit cards tend to carry some of the highest interest rates in the credit world with some providers charging as much as 29%! Furthermore, because of their flexibility credit cards are notoriously easy to become overly reliant on.

Credit Card Alternatives

One alternative to using credit cards is a revolving credit facility. A revolving credit facility is kind of like a flexible loan which a business can draw down when it needs to, repay when it can, and then draw down again as it wishes.

For example, if our business gets a revolving credit facility for $20,000, we are not obliged to use the whole $20,000 but only what we need. So, we could draw down $10,000 to pay an invoice and keep the other $10,000 in reserve. If we then repaid $5,000 of the $10,000 we drew down, we would then have $15,000 available to use.

Final Thoughts on Unsecured Business Financing

As you can see, there are multiple different business line of credit available. Overdrafts and credit cards are perhaps the most common unsecured line of credit available, but also the most dangerous. As such a business that needs to obtain unsecured business financing may instead wish to try and obtain an unsecured loan or one of the credit card alternatives such as a revolving credit facility.

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