Coming up with the funds you need to make essential purchases for your small business is always a challenge. For entrepreneurs, this sometimes means relying on personal credit cards and your credit history to access the capital you need to keep moving forward.
According to a 2017 year-end report by the trade group, the National Small Business Association, 27% of small businesses were unable to obtain adequate financing. The SBA states that 46% of small businesses use personal credit cards.
Revolving credit is one tool that small business owners can use to get the funding they need.
What Is Revolving Credit?
A revolving credit account works much like a credit card. It allows you to borrow up to your credit limit and pay back the borrowed money over time. Once you start paying off your loan, you can borrow from the line again.
For example, if you used $25,000 of your $50,000 credit limit then pay it off, you’ll have $50,000 worth of credit to draw from again.
This is different from most small business loans. With a conventional loan, business owners are given the funding upfront, and they pay it back over time. If business owners want access to funding again in the future, they have to apply for a new loan.
Advantages of Revolving Credit for Business
The key benefit that business owners get from revolving credit is that you don’t have to keep applying for loans or additional lines of credit. Once your revolving credit account is secured, it’s always there for as long as you have credit available and are in good standing.
There are additional benefits, including:
- The opportunity to separate personal and business lines of credit
- The ability to build business credit
- More flexible payment terms
- Cash on demand (in some arrangements)
- The ability to use the line of credit when needed.
When Is Revolving Credit a Good Option?
A revolving line of credit can help you plan for the future, providing working capital to make essential purchases and help your business expand. With this kind of financing, there are several options to choose from. Revolving credit is often a good option in some instances:
- You’re hiring new employees in preparation for growth
- You need to stock up on inventory
- You operate a seasonal business
- You get a big new customer and may need to front some expenses
Revolving Credit Examples
Aside from business credit cards, there are 3 other types of business revolving credit you should be aware of. They are:
- Short-term revolving lines of credit
- Medium-term revolving lines of credit
- Bank lines of credit
Short-Term Revolving Credit
A short-term revolving line of credit has a repayment term of 18 months or less. It is similar to a short-term loan in the amount of funding you can secure, and its interest rates are similar as well. The limits on short-term lines of credit are generally lower than longer-term options.
If you are operating a new business and you don’t have much credit established yet, a short-term line of credit may be a good option. It’s easier to get approved. Just keep in mind that the interest rates on a short-term line of credit will be higher.
Medium-Term Revolving Credit
A medium-term revolving line of credit gives you the option to repay over 1 or more years. You can also secure a higher limit (some credit lines can reach more than $1 million).
Applying for a medium-term option is typically more challenging. You’ll need a significant amount of documentation to apply, and your application will take longer to process.
This is a good option if you are an established small business planning for the future, but not if you need capital immediately.
Bank Lines of Credit
There are plenty of nonbank lenders and revolving credit facilities online that can provide you with revolving lines of credit. However, you can still walk into a bank branch and apply for conventional financing.
Other Types of Business Credit
Technically, a line of business credit is a loan. However, it doesn’t work the same way as traditional business loans. Instead of accepting a lump sum and paying back your loan in installments, your line of credit gives you access to funds up to your credit limit.
Furthermore, you only pay interest on the money you’ve drawn (much like a personal credit card).
There are 2 models for a business line of credit: secured and unsecured.
A secured line of credit is backed by a cash deposit or collateral which you must provide before receiving the line of credit. An unsecured line of credit has no collateral associated with it.
There are 3 different types of business credit lines aside from revolving credit.
Conventional Unsecured Business Line of Credit
A standard unsecured business line of credit requires no collateral, nor does it require a down payment. It’s typically easier to get a business line of credit than over types of business credit, especially if your business has a strong credit history. The application process is more straightforward, too.
That said, this line of credit may come with higher interest rates and a maintenance fee.
Conventional Secured Business Line of Credit
In this arrangement, you must put up something of value as collateral to obtain the line of credit. This could be a business asset, real estate or a cash deposit. This serves as a guarantee to the lending institution. If you default on repayment, they can claim your collateral as payment instead.
A secured business line of credit usually has better terms because of the collateral involved. It may have lower interest rates, lower or no maintenance fees and more flexible repayment options.
Business Credit Card
A business credit card works similarly to a personal credit card. You have a credit limit and can use the card at the point-of-sale to make business purchases. Interest is only accrued on the credit you use, and you make repayments based on set rates.
The key difference between business and personal cards is that business credit cards typically come with perks and rewards that benefit your business, not just you as an individual. The limits on business credit cards also tend to be much higher than on personal credit cards. Rewards could include a sign-on bonus, redeemable points toward business expenses (such as travel), cashback, gift cards and more.
The Bottom Line
If you regularly need access to credit for your small business, a revolving credit account may be just the thing.
Whether it’s a business credit card or a line of credit—secured or unsecured—contact a financing specialist to learn about your options.