As a small business owner you’ll inevitably need capital to start, build or grow your business. How to acquire that funding is up to you. And that prospect can be overwhelming when considering the myriad of other decisions, you’re likely facing in operating your business.
While there are multiple options available to secure funding, business lines of credit, business credit cards and business loans are some of the most common. Each of these tools serve a unique purpose to help you run your business. Knowing the differences between them will help you make an informed decision about what is best for your company when you need capital.
Business lines of credit
By and large, lines of credit are used to finance ongoing operating expenses and short-term financing needs, such as payroll, short-term cash flow shortages, or seasonal expenses. It is something you obtain before you need it.
Lines of credit are often referred to as “revolving,” which means you can tap into them again and again. For example, if you have a $75,000 line of credit for your business and use $30,000, you still have access to the remaining $45,000. If you pay back the $30,000, you will have access to the full $75,000 without having to reapply.
Borrowers are required to make monthly, sometimes quarterly, interest payments on the line of credit. Principal payments do not follow a set schedule and usually borrowers use their excess cash flows to pay down the outstanding balance on the line of credit. Typically banks prefer for lines of credit to be backed by collateral, but in some instances they may be unsecured.
Most importantly – don’t tie up your line of credit paying for long-term investments, because this will limit your flexibility and prevent access to funds in an emergency.
Business credit cards
Business credit cards – which function just like personal credit cards – are very similar to lines of credit in that they are used for short-term funding needs such as operating expenses. The biggest difference is that more often than not they are unsecured and therefore carry higher interest rates.
As a result, the larger the amount you need, the more sense it typically makes to apply for a line of credit. That’s because it’s cheaper for you and is typically less risky for the bank
Small business loans are ideal for long-term investments like buying equipment or making improvements to your plant or office. When you apply, you’ll need to show exactly what your plan for the money is and how it will help your business. If you’ve been in business for a long time, you’ll likely have an easier time getting approved for a loan. That’s because banks want to see a track record of success.
When you use a small business term loan to access capital, you borrow a lump sum of money, get it all at once and pay it back over a specific period of time, also known as the “term. Most banks prefer loans to be backed by collateral, but sometimes there are options for unsecured term notes – just check with your banker.
When you apply for a loan, your banker will likely provide you with options of different repayment periods and fixed or variable rates for you to choose from. Once you’ve been given the funds you’ll need to start repaying the loan immediately, even if you don’t use the money right away.
Closing costs and interest rates for term loans are typically higher than those on a business line of credit. And – as opposed to a revolving line of credit – once you use up all the loan funds, you’ll need to reapply for a new loan.
Selecting one of these financing options over another will ultimately depend on your specific needs and goals – and your banker will help you determine the best source of capital. If you have further questions about your options, don’t hesitate to reach out to your local MidWestOne small business banker.