Business Credit
3 business scenarios that need money to make money
"If you're trying to start a business today, you can almost forget about going to a bank for financing, wrote a loan broker on the New York Times' small business blog in 2013. It's no secret that traditional bank loans are hard to come by even for the most successful small businesses, especially in the years since the financial crisis.
According to Karen Gordon Mills, former Administrator of the US Small Business Administration, banks are reluctant to process loans under $100,000, which happen to account for the majority of loans sought by small businesses. Where can small business owners go for the cash they need to grow and maintain their companies?
In the first of this two-part series, we'll explore the pros, cons, and uses of three common financing options: business credit cards, term loans, and lines of credit. (In the next article, we'll look at invoice factoring, credit card receivables financing, and merchant cash advance.)
Like a personal or corporate credit card, a small business credit card is a revolving line of credit you're expected to repay within the month.
What type of business is it for?
Credit cards are available to businesses of any size, including sole proprietorships, in any industry.
What are some appropriate use cases?
Business credit cards are best for covering short-term fluctuations in expenses, such as emergencies and small purchases outside of your budget, not huge costs.
Pros
Business credit cards help separate your personal and business expenses, are convenient and easy to qualify for, make online transactions easier, provide a financial cushion for emergencies, and can make accounting simpler. They often come with rewards like cash back and benefits like flexible repayment terms, and large sign-up bonuses. You can also add authorized users to your account, allowing them to make purchases.
Cons
With interest rates topping 15%, credit card debt is very expensive. The CARD Act, which took effect in 2010 to reform credit industry practices like raising interest rates on existing accounts, does not apply to business cards. You are also personally liable for credit card debt. Use cards responsibly.
Term loans, the type of loans Bond Street offers, function like mortgages. You borrow a specific amount of capital and repay the loan on a set schedule. Intermediate-term loans like Bond Street's run up to three years and are repaid from a business' cash flow. Long-term loans are collateralized and run from 3 to 20 years.
What type of small business is it most ideal for?
Term loans are best for established small businesses with a stable income. When making decisions about term loans, creditors look at your character (i.e. your debt repayment history), credit capacity, collateral, capital, and confidence in the business plan; strength in these 5 C's will help secure a loan with good terms.
What are some appropriate use cases?
A term loan is perfect for making a large, one-time investment that will create income to grow your business enough to pay back the loan over time. Such investments include opening a new location, hiring more employees, upgrading a website, and buying new machinery, inventory, or equipment. Term loans are not appropriate for short-term investments that can be repaid over several months.
Pros
Term loans often make investment in long-term business growth possible and generally offer lower interest rates than credit cards. Interest rates are usually fixed, so payments can be allocated in a monthly budget.
Cons
Lacking in the 5 C's may mean high interest rates, if you qualify at all. Term loans with a floating or variable interest rate can also ultimately cost more than anticipated.
Lines of credit are large amounts of capital you have access to, up to a certain maximum. When you draw down from a line of credit, cash is made available in your business checking account. This cash is a short-term loan you must pay interest on until it is paid back.
What type of small business is it most ideal for?
Lines of credit are best for businesses with revenue swings and payment lags, like seasonal businesses including summer camps and snow removal contractors. To qualify for a line of credit, a business usually needs to be at least 2 years old, have a positive net worth, and be profitable for at least one year.
What are some appropriate use cases?
Lines of credit are best used for short-term purposes incurring costs you can repay in 12 months, such as stocking up on inventory, smoothing payroll, operating costs, and business cycle needs. They're not appropriate for large investments like real estate or equipment.
Pros
Because it allows access to cash when you need it, a line of credit provides lots of flexibility. You only make payments on the amount you've borrowed. The interest on lines of credit are often lower than on credit cards and loans, especially if you apply for one when you don't need it so that you qualify with favorable terms.
Cons
The interest rates on lines of credit are normally variable. Lines of credit require up-front and annual fees. If it is classified as a "demand loan, the lender may be able to ask you to pay outstanding balances immediately. A small business' line of credit must usually be secured by personal assets.
Business credit cards, term loans, and lines of credit all share another benefit: responsible use can help raise your Paydex score, improving your chances of obtaining future financing from any vendor at favorable terms. Each of these options comes with a unique set of pros and cons that make it ideal in some circumstances and unwise in others. Understand your choices. Your business will benefit.
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