Loans or Lines of Credit: What's best for your business?
When you own a small business, finding the right type of financing is the key to growth. There are many options available today, but the two most common options are: business loans and business lines of credit.
Answer these questions before selecting the best way to finance your business:
- What is the purpose of the loan?
- How much money do you need?
- When do you need the money?
- How long will it take you to pay it back?
- How long have you been in business?
- What is your credit score?
- What do your current finances (personal & business) look like?
- If you need collateral, do you have any to put up for the loan?
- Do you have a business plan?
You may want to gather some materials beforehand and make sure you have a strong business plan. Some of the items you may need to include are:
- Executive Summary
- Company Description
- Industry Overview
- Description of organization / business overview
- Description of products and services
- Funding Request
- Projection of finance for next 3-5 years
- Financial statements and assumptions
- Credit history (business / business owner)
- Resume of any investors or any other affiliations
You should understand the differences as well as any advantages / disadvantages of each and you should have a clear understanding of why you need to borrow money.
A Business Loan (BL) is where you borrow a substantial sum of money for specific business purposes. The sum is paid to you all at once and you are required to return it within a specific amount of time.
A SBA Guarantee is where banks and other lending institutions offer many Small Business Administration (SBA) loan programs to assist small businesses. The SBA does not make loans, it does guarantee loans made to small businesses by private and other institutions.
A Line of Credit (LOC) is like your personal line of credit, such as credit cards. This allows you to withdraw funds up to a predetermined amount and pay monthly payments and pay interest charges on the outstanding balance.
Let's look at the differences, advantages, and disadvantages of each:
1. Timing: When you apply for a loan or a line of credit, you need to know when you are going to use it. A loan is something you get when you need it, and for specific purposes. In contrast, a line of credit is usually set up before you need it and can serve multiple purposes.
2. Monthly Payments: With a loan, your monthly payments begin immediately and don't change from month to month, whether you are using all the money or not. With a line of credit, your payments only reflect the amount of money you've borrowed and you only make payments on the amount you borrowed.
3. Renewals: Business loans do not renew at the end of the terms, you must reapply. While a loan of credit is revolving, you can use it multiple times.
4. Long-term vs Short-term: Loans are usually paid off in 2 to 6 years. Lines of credit can solve short-term problems.
5. Interest Rates: With a business loan, you are likely to have higher interest rates that are fixed, whereas a line of credit may offer lower variable rates. With a line of credit, if you are late on a payment or exceed your credit limit, your interest rates will increase.
With such a wide range of financial options available to small business owners, it can be difficult to choose the right one. But, knowing the difference between two of the most common financing solutions can help paint a bigger picture to what you are really looking for. You want to make the best decisions so that you can make the money work for your business.