Unsecured Business Line of Credit for Startups | SMB Compass
Ezra Cabrera | August 12, 2021
A business line of credit can range anywhere from $10,000 to $1 million. Term lengths can vary greatly – ranging anywhere from six months to five years – as well as interest rates, with some as low as 7% and others as high as 25%.
According to data from the Federal Reserve, the average business line of credit that lenders provide is around $22,000.
Key Takeaways
- Startups can gain access to additional funding by applying for a business line of credit.
- A business line of credit is a revolving loan, which means that the company will only have to repay the amount it spends and will only have to pay interest depending on the amount borrowed.
- A secured business line of credit requires borrowers to put up assets as security. On the other hand, an unsecured business LOC requires no collateral.
Any business, regardless of size or industry, requires funding to launch. Some aspiring entrepreneurs may turn to their own bank accounts for this, whereas others may turn to angel investors. As the business progresses, the business owner may then realize that additional funding needs to be raised so that the company can continue to grow and develop.
One good way for a newly launched business to gain access to additional funding is to apply for a business line of credit for startups.
What Is a Business Line of Credit?
The simplest explanation is that a business line of credit functions in the same way as a non-physical business credit card. When a company qualifies for a line of credit (LOC), it is granted access to a credit limit. Because a LOC is a revolving loan, the company will only have to repay the amount it spends and will only have to pay interest depending on the amount borrowed. A business can use a business line of credit to borrow cash and repay it as needed, given that the outstanding balance does not exceed the credit limit.
So, why do they care so much about a borrower’s credit standing?
Think about it from the lender’s perspective. They want to know that you’re going to be able to make loan repayments on time and in full by the end of the financing period. A credit check is how they assess your credit and repayment behaviors to gauge what their level of risk is in lending to you.
Your credit report shows all your financial activities including your debt accounts and their current status, the payments that go towards each account, and more. Banks and traditional lenders check your credit report to assess how responsible and reliable you are in making repayments, and whether or not you have a tendency to end up defaulting on your loans.
Within your credit report is your credit score. Although it’s just a three-digit number, it can show a lot about a person’s credit behavior. Essentially, the higher the number is, the more likely you are to make repayments on time and repay the loan in full. In turn, the lenders will see you as an ideal borrower, and they’re more likely to extend credit with excellent terms to you.
The opposite, however, won’t work favorably to your advantage. Low credit scores could indicate an irresponsible payment behavior and a high chance of default, making you a high-risk borrower. While some lenders may still be willing to work with you, you can’t expect that their terms will be as flexible.
Is a Business Line of Credit the Same as a Business Credit Card?
The quick answer is no. A business line of credit is a revolving loan that allows small business owners to borrow a specific amount of money on a regular basis. The funds may then be used to meet immediate business needs. Businesses typically use a line of credit to cover short-term working capital needs such as inventory purchases, marketing campaigns, and necessary equipment maintenance. It may also be used to bridge seasonal cash flow deficits.
Business credit cards also allow business owners to gain access to additional capital, and they too are considered a revolving loan. The main difference between the two is that business credit cards offer much lower credit limits than a business LOC.
That said, some business owners prefer a business credit card because it allows them to better track their spending. Certain business credit cards will also come with rewards programs that can help entrepreneurs save when paying for common business expenses such as office supplies. Furthermore, some offer 0% APR for first-time users while others have more flexible repayment terms. However, many of them have high interest rates.
What Is an Unsecured Line of Credit?
Some business funding alternatives require potential borrowers to put up an asset, known as collateral, as security for the loan. This asset could be real estate, goods, equipment, or another asset of value that the company possesses.
For example, an equipment loan is usually secured by the equipment purchased from the amount funded by the loan. If the borrower isn’t able to pay on time, the lender can then take said equipment and sell it to someone else. The asset, in this case the equipment, already helps repay the loan.
What startup founders and decision-makers should know is that unsecured business lines of credit are not the same as secured business lines of credit.
There is no collateral or security deposit to backup an unsecured LOC. This is why a company may be authorized or denied this type of funding based on a very close look at its qualification criteria. This includes the company’s credit score, financial situation, and any other qualifications that a lender deems relevant.
Who Offers Business Lines of Credit?
Banks are more commonly thought of as the traditional lender that provides business lines of credit. They tend to offer larger credit amounts, but also have a longer application process with more stringent criteria. For example, most banks will require businesses to have been in operation for a certain number of years and show significant sales. Banks tend to be wary of providing LOCs to startups or newer businesses.
Depending on the lender, the amount available under a business line of credit varies significantly. For example, non-bank lenders (such as online lenders) have fewer qualification requirements but offer lower credit limits.
A Guide to Applying for a Business Line of Credit for Startups
It’s now quite simple to apply for a business line of credit. Most lenders allow potential borrowers to apply online, eliminating the need for a face-to-face appointment.
For startups, however, it’s good to note that online lenders want to get a full picture of the company’s operations. Examples of documents that they may ask for include personal and business tax returns, financial statements from the business’s bank account, business registration documents, credit references, and annual revenues.
It’s helpful for a startup to provide as much financial information as possible since the company has little or no operating history. Previous transaction records may also be included, such as invoices paid to vendors or unpaid accounts receivables. What applicants should keep in mind is that the application must persuade the lender that the startup will be able to fully repay its debts.
Lenders prefer to lend money to companies that have been in operation for at least six to twelve months. They’ll also be interested in seeing a consistent cash flow, some history of financial success, and a good credit history. The startup owner’s personal financial history and credit score may also be taken into consideration.
How a Startup Can Increase Its Chances of Qualifying for a Business Line of Credit
New businesses can increase their chances of getting approved for a business line of credit in the same way that they can for any other business loan. One method is to put up collateral, which is known as a secured line of credit.
Collateral doesn’t necessarily have to be a major asset like a vehicle, equipment, or real estate. A startup founder may be able to pledge alternative sources of funds for a business line of credit. A lender, for example, might let an applicant pledge the value of their accounts receivables. This is known as invoice financing.
Another alternative is to establish personal or corporate credit before applying. Paying off corporate credit cards on schedule, for example, shows lenders that a startup can manage credit responsibly. The company owner/s may also opt to increase their personal credit scores, especially if the lender conducts personal credit checks as part of the application process.
A startup might be able to get an unsecured business line of credit instead of applying for more working capital if it waits until the company is more established. It may not be necessary to submit collateral if it can be proven that company finances are stable and up to date.
A Closer Look at a Secured Business Line of Credit
When a business owner gets a secured business line of credit, the lender normally puts a lien on the asset being used to secure the funding. The sorts of assets that a lender may take as collateral vary. Some examples are vehicles, inventory, cash, financial securities (such as CDs, stocks, and bonds), real estate (whether business or personal), equipment, and even invoices.
It’s sometimes easier to qualify for a secured business line of credit than an unsecured one because of the collateral. Collateral, in the perspective of a lender, minimizes risk, which then makes for a more appealing borrower.
Putting up assets, though, can do more than just improve one’s qualification chances. Collateral may also help a loan applicant secure lower rates, higher credit limits, and better terms from a lender.
A Closer Look at an Unsecured Business Line of Credit
Many business owners, of course, prefer to obtain funding without putting their assets on the line. Some companies, particularly startups, may not yet even have any assets that a lender would consider acceptable.
If a business falls into one of these categories, then an unsecured business line of credit might be a better fit.
An unsecured business line of credit functions more similarly to a business credit card. This is simply because money can be borrowed up to the account limit and, as long as the account is well-managed and balances are always paid, the account holder can borrow again against the same line of credit in the future. There’s no need to put up collateral to back the money that the company borrows. Though this reduces the risk a borrower takes, it means more risk for the lender which results in higher costs. This is why unsecured LOCs typically cost more than secured ones.
To offset their risk, lenders that issue unsecured business lines of credit may opt to charge higher interest rates and fees, issue lower credit limits, and ask for shorter payback terms with bigger monthly payments. Some may also ask borrowers to sign a personal guarantee.
However, this doesn’t mean that an unsecured business line of credit is a bad choice. Loan applicants just need to consider both the advantages and disadvantages of each option before choosing one.
Personal Guarantees on Unsecured Lines of Credit
Lenders will only approve business funding requests if they are okay with the risk. If an applicant doesn’t have any collateral to put up as security for a business line of credit, a personal guarantee may be requested instead.
A personal guarantee (PG) basically makes the borrower a co-signer on the business’ credit line. The borrower then guarantees to reimburse the obligation if the company fails to do so. It’s another approach for a lender to verify that the business owner is willing to take some risk despite not putting up an asset as collateral.
However, it’s important to note that personal guarantees may be required for some secured business lines of credit. This is why it’s always best to read the fine print and ask the lender questions regarding personal guarantee requirements before applying for a line of credit or any type of loan.
Comparing the Unsecured Business Lines of Credit by Different Lenders
One of the most important factors to consider while researching financing options is the cost. How much will it cost for the borrower to get the money needed?
Two questions need to be asked. The first is, “What will the lender’s interest rate be?” The second is, “Are there any other charges?”
To help answer the questions above, here are three popular lenders that offer business lines of credit, along with the current rates and fees that each one charges:
Wells Fargo
Wells Fargo is the fourth-largest bank in the United States. It provides small business customers with a variety of financial products, including credit cards, commercial bank accounts, and a variety of financing choices, including business lines of credit.
Wells Fargo’s unsecured business line of credit has a credit maximum of $100,000. The first year’s annual charge is waived. After the first year, though, the fee is $95 for credit limits up to $25,000 and $175 for credit limits over that amount. Moreover, if the account holder uses an ATM or a BusinessLine Mastercard to access their funds, they will be charged a 4% cash advance fee. According to the company’s website, this cost is not charged for checks, online and phone transfers, or online bill payments.
To be eligible, a company should have been in operation for at least two years. A personal guarantee is required from all business owners who own 25% or more of the company.
It’s important to note that startups can get an unsecured business line of credit from Wells Fargo. The bank also offers the SBA-backed Wells Fargo Small Business Advantage Line of Credit. It’s best for businesses that haven’t been around for more than two years. To be eligible, the startup must be a for-profit company that meets the SBA’s requirements.
Chase
Chase is currently the biggest commercial bank in the U.S., and it is well-known for providing a number of business credit card options to small business owners. However, Chase also offers business lines of credit up to $500,000.
When it comes to rates and costs, Chase isn’t as upfront online as some other lenders. The APR is determined by factors such as the applicant’s relationship with the bank, credit history, and whether any collateral is put up, according to the bank’s website. There is an annual charge for the account, but it is waived automatically if the average LOC utilization is 40% or greater.
Bank of America
Bank of America is another major bank that provides small businesses with business credit cards, commercial bank accounts, and merchant services. Bank of America also offers up to $100,000 in business lines of credit.
A personal FICO credit score of at least 670 is required to qualify for a Bank of America Business Advantage Credit Line. The company must also have been in operation for at least two years under the present owner and generate at least $100,000 in annual revenue.
New accounts generally have a $150 origination fee, though the bank periodically offers limited-time deals.
Applicants should note that Bank of America’s funding process is quite slow. Once qualified, applicants may have to wait up to ten business days to get their funding.
Final Thoughts
A business line of credit is a type of revolving loan that functions similarly to a credit card. For example, if a borrower is given $100,000 in credit, then they can use it whenever they want and will only be charged interest on the balance they owe. The business can then use $10,000 of this credit to pay, for example, for equipment to help with product development. This means that the business still has $90,000 leftover to use at a later point. This is why revolving loans are quite popular among businesses that qualify.
Borrowers will be able to withdraw the funds that they need, which gives them immediate access to cash, unlike with a credit card. Many short-term capital needs, which might range from project costs to inventory purchases, may be met using lines of credit.
Most banks provide a business line of credit. However, it’s important to remember that applying for a business line of credit is already challenging, and applying via a bank makes it even more difficult.
Though many types of loans aren’t available to newer businesses, there are ways to find the right business line of credit for a startup. Instead, they may consider applying for a business line of credit from an alternative lender. These lenders usually have less stringent requirements and easier application processes. Banks, on the other hand, may require collateral or have stringent criteria that need to be met. The only way for a startup to find the best deal is to weigh all of its options.
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