The Pros and Cons of a Startup Business Line of Credit

Learn How Business Lines of Credit Work

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Businesses need a steady cash flow to remain operational. A startup business line of credit can help with this. It is a type of small business financing that works like a credit card: you can withdraw funds and pay them back with interest.

Knowing more about this business financing can help you decide if it’s the right fit for your needs. Here, we’ll discuss what a startup business line of credit is as well as the pros and cons of using one.

Key Takeaways

  • A startup business line of credit is a flexible financing option that works similar to a credit card.
  • Businesses with lines of credit can borrow funds anytime and pay the money back in smaller payments with interest.
  • Credit lines have lower limits than other financing options, but they also have more flexible terms for how you use them.

What Is a Startup Business Line of Credit?

A startup business line of credit is a flexible type of business financing whereby startups can get access to funds as needed. The startups repay the funds at a later date with a fixed rate of interest.

Using a startup business line of credit is similar to using a credit card, as both have a revolving line of credit. The difference is that compared to a credit card, a startup business line of credit typically offers better rates, higher spending limits, and other potential business advantages.

There are two main types of startup business lines of credit: secured and unsecured. A secured line of credit requires collateral but has lower interest rates. An unsecured line of credit doesn’t require collateral yet tends to have higher interest rates.

Different lenders have varying requirements for startups to qualify for lines of credit. For example, a bank may require that a startup be operational for at least two years. In contrast, alternative lenders may be willing to work with newer startups, though they could charge a larger starting fee or higher interest rate.

Pros and Cons of Startup Business Lines of Credit

A startup business line of credit can be a beneficial tool for many entrepreneurs, but like most financing options, it’s not for everyone. Here are some pros and cons to keep in mind when choosing whether to get a startup business line of credit.

Pros
    • Provides a steady cash flow
    • Only pay for what you use
    • No cash advance fees
Cons
    • Tighter qualification criteria for startups
    • Requires upfront fees
    • Generally has lower limits than a business loan

Pros Explained

  • Provides a steady cash flow: A startup business line of credit is a flexible financing option, which means startups can access funds when they need them and use them for a variety of business needs. This can help with cash flow problems and maintain steady business capital.
  • Only pay for what you use: While a startup business line of credit offers a fixed sum to use, not all startups use the entirety of the money available to them. The good news? You only pay interest on the amount of money you use. So if you have a $100,000 line of credit, and you only use $50,000 in a given time period, you only pay the specified rate of interest on the $50,000.
  • No cash advance fees: A business line of credit offers revolving credit that, unlike a business credit card, does not charge cash advance fees. Another advantage a business line of credit has over a credit card is the ability to write checks to pay collectors that do not accept credit cards.

Cons Explained

  • Tighter qualification criteria for startups: Most traditional lenders require startups to be operational for at least two years before qualifying for a business line of credit. Newer startups may be denied. Alternative lenders that agree to work with such newer startups charge higher rates.
  • Requires upfront fees: Starting a business line of credit typically requires startups to pay different upfront costs like opening fees or one-time investment fees. These fees, combined with the interest rates on the borrowed money, make it an expensive option for many startups.
  • Generally has lower limits than a business loan: A startup business line of credit has lower limits compared to traditional business loans. Likewise, the borrowing limits (the amounts of money available) may be lower. Payback time may be shorter and interest rates higher, making it a complicated option compared to other forms of business financing.

Is a Business Line of Credit Right for You?

A startup business line of credit might be right for you if:

  • You have already invested money in your business.
  • You only need access to smaller sums of money.
  • Your startup has been operational for more than two years.
  • You want to build a good credit history.

A startup business line of credit might not be right for you if:

  • You don’t have a lot of capital invested in your business.
  • You want to fund major purchases like buying land or heavy machinery.
  • You just launched your startup in the last few months.
  • You can't afford recurring interest rate charges.

Alternatives to a Business Line of Credit

A startup business line of credit may not be the right option for all new businesses. You can consider other business financing options to keep your business running.

Small business loans are a common alternative to a business line of credit. Compared to credit lines, loans have bigger terms but less-flexible options for how you can use the funds.

Startups may also turn to crowdfunding for funds and rely on collected contributions. Online platforms like Kickstarter and GoFundMe help startups raise money.

Some other alternatives to business lines of credit for startups include business grants and venture capital investments.

Frequently Asked Questions (FAQs)

How do you get a business line of credit?

You can acquire a business line of credit in various ways. You can directly approach traditional institutions like banks, fill out their applications, and wait for approval. You can also approach alternative lenders (through various online and offline platforms) to find a lender with terms that meet your business’s specific needs.

How much does it cost to apply for a business line of credit?

The cost to apply for a business line of credit depends on the lender. Some lenders have annual fees that may be fixed or a percentage of sum. You may also be required to make a one-time payment to start a line of credit that varies by the lender.

What is the usual line of credit for a new business?

The line of credit offered to a startup depends on the business’s collateral, its credit history, how long it’s been running, and its current financial position. New businesses with little to no collateral and minimal credit history may be eligible for a business line of credit of a few thousand dollars, while more established businesses may be eligible for six-figure credit lines.