Landing and maintaining an unsecured line of credit for your business
By Gwen Moran
For small businesses with few assets seeking the flexibility of on-demand funds, an unsecured line of credit can be an ideal option. Unsecured lines -- which are riskier because it is not secured by collateral -- shriveled during the recession, but today, with a little effort and luck, you might find it to be the answer to your business's borrowing needs.
A number of indicators point to an easing of the tight credit that kept small businesses battling for loan dollars during the Great Recession. The Biz2Credit Small Business Lending Index, a monthly analysis of loan applications, found that big bank loan approval rates for small businesses rose by more than 62 percent in August 2013 compared to a year earlier.
The Federal Reserve's July 2013 Senior Loan Officer Opinion Survey on bank lending also signals easier days for small businesses looking for loans. The report says that banks eased lending standards and terms in the second quarter for businesses of all sizes. In particular, banks decreased the cost of credit lines, according to the report.
"It's a myth that unsecured lines of credit aren't available to small businesses, but banks are going to be looking for a good track record and other indicators that you're a good risk," says former finance industry executive Mitchell D. Weiss, an adjunct professor of finance at the University of Hartford in Hartford, Conn.
Looking for your own small-business line? Acquiring and maintaining this important financial tool requires some important steps.
Clean up your personal finances. Weiss says that one of the first things lenders are going to check is how you manage your own finances. Generally, you're going to need to show that you've accumulated some personal assets -- savings or real estate, for example -- and have a FICO score north of 680, says Biz2Credit founder Rohit Arora. Even unsecured lines generally require a personal guarantee, at least at first. Be sure to check both your business and personal credit scores and allow yourself enough time to correct mistakes -- 60 days or more -- before applying.
Get serious about receivables. In addition to solid personal finances, you're going to need to show that your business collects the money owed to it, says Weiss. Get your receivables up-to-date and show that you have healthy cash flow that will allow you to pay down the line of credit as needed.
Prove your case. Matt Inglot, founder of Web design firm Twisted Pixel in Waterloo, Ontario, landed his firm's five-figure line of credit during the throes of the recession. (While Canada's banking system is not exactly the same as that of the U.S., it is similar enough that his experience is relevant.) Inglot carefully assembled his paperwork, which included two years of business tax returns, a carefully completed loan application, and a profit-and-loss statement prepared by his accountant, which he says added credibility.
He also had a solid rationale for the request, since his firm usually must wait until the work is complete to receive its project fees (excluding a deposit, which the company collects upfront). He showed the bank how a line of credit would allow him to bridge those payment gaps so he could take on more business. He was also able to answer questions about revenue and profit margins to show that he had a solid understanding of his business finances.
"You don't want to go into the bank and say something generic, like, 'I want to help my business grow,' because the bank is not there to be an investor with you," Inglot says. "You will have better success if you come in with a specific problem and show them how this can solve the problem and not put their money at risk."
Understand the costs. Weiss warns small-business owners to fully understand the terms of the credit line before committing. He says a proliferation of "alternative" lenders offer the business equivalent of payday loans. Weiss says these short-term solution providers protest such allegations, arguing the loans are designed to be paid off in a month or two. But when you add up the interest rate and fees, some reach an annualized interest rate of 50 percent.
Arora says businesses should expect to pay somewhere around U.S. Prime (currently 3.25 percent) plus one to five percentage points, depending on their business and personal credit scores, open credit lines and balances, business history and industry. Professional services firms such as accounting or law firms, which have business-to-business clients, may be considered more stable than retail businesses, and bars and restaurants, which often have to pay more.
For businesses that have trouble qualifying for unsecured lines of credit from the bank, the Small Business Administration has programs that offer loan guarantees to the bank. Find an SBA-approved lender in your area by checking out the SBA website or consulting your local Small Business Development Center.
Inspect additional terms. The lender may also require you to sign an agreement saying that you will maintain certain cash levels or pay down the balance within a specific time period. Make sure you understand exactly what's required.
Also, get details on how the money can be accessed. In Inglot's case, the line of credit is linked to his business checking account. He can draw on it by simply writing a check or otherwise making a transfer. When he makes deposits into the account, they are credited toward the open balance until it's satisfied, essentially working like overdraft protection. Other lines may be independent of your financial accounts, but be accessed like a credit card or checking account.
Manage your line responsibly. Even if you make all of your payments on time, if you fail to meet another aspect of the loan terms you could find yourself in "technical default," which could lead to the loss of your credit line, Weiss says. That's why it's important to manage the line of credit carefully once you've landed it. If you've agreed to maintain certain cash or debt ratios, the bank will want to see reports proving you're doing so. While it's unlikely the lender will take legal action for a technical default, it's possible that the line won't be extended again on its renewal date. A few years of managing his line well allowed Inglot to double it in 2012 to accommodate his growing business.
Unsecured credit lines offer financial flexibility without the constraints of placing a lien against your business assets. With proper preparation and management, you can maintain and possibly increase them to smooth cash flow and make important short-term investments in your business.See related: 8 steps to build your business credit profile, Creative financing for small businesses, How businesses can start on the road to credit
Published: September 30, 2013
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