Is a Loan or Line of Credit Best for My Business?

Selecting the proper loan product for your business depends on what you need the money for and how you intend to pay it back. Here are some quick facts about each product.

Business Loans

• Usually term loans in which borrow a lump sum of money and pay it back over a specified period of time (or “term”), normally ranging from one to 20 years.
• Preferable for specific, major projects, such as capital improvements, purchasing commercial real estate for constructing or expanding your business, establishing a long-term marketing plan, buying equipment and vehicles and debt consolidation.
• Different repayment periods available fixed or variable interest rates.
• Interest accrues immediately, since you receive the entire amount up front, so you must begin paying interest whether or not your business uses the capital right away.
• Closing costs and interest rates in general are higher on a term loan.
• Term loans are static. Once you use all the money you borrowed, you’ll have to reapply for a new loan if you need additional funds.

Business Lines of Credit

• A revolving line of credit that provides easy, convenient access to the money.
• Used for short-term capital needs or seasonal fluctuations.
• You may choose when and how much to utilize from your credit line, so your monthly payment and interest charge is based on what you actually borrow, not the entire credit limit. This can save you money on interest payments.
• The more you utilize your credit line, the higher your payments and interest charges will be.
• Business lines of credit may be renewed every year to every couple of years.

Collateral Considerations

Most banks and traditional lenders require that business loans and lines of credit be secured with some form of collateral, although unsecured term loans are a possibility with some lenders. Secured loans, however, generally have lower interest rates and more agreeable terms.

What assets can you use as collateral?

• real estate
• equipment
• buildings
• accounts receivable
• inventory (in some cases)

Lenders consider such items possible sources of repayment if they can be sold by the bank for cash. Collateral can consist of assets that are usable in the business as well as personal assets that remain outside the business. They can also be assets purchased or financed with the funds you borrow.

Professional appraisals of both business and personal assets may be required, particularly for loans greater than $100,000 secured by commercial real estate. In addition, a survey and/or feasibility study may be necessary. When real estate is being used as collateral, banks and other regulated lenders are required by law to obtain third-party valuation on transactions of $50,000 or more.

A good business credit rating and a solid, company financial history are required for both types of loans. Few lenders will approve lines of credit for start-ups or businesses without a track record of financial success.

Business lines of credit are almost always asset-based, with hard assets, like equipment or facilities, used as collateral. Credit lines can also be secured by receivables and even inventory – although inventory is less likely because its value can shrink rapidly, especially if your business is seasonal or cyclical.

Small Business Considerations

The U.S. Small Business Administration offers loans to small business owners through participating lenders. The programs are varied and the qualifications are specific. Contact your lender to see if your business qualifies for an SBA loan.

Rieva Lesonsky, who has spent more than 30 years consulting with small businesses owners and entrepreneurs, offers some concrete examples of how both types of loans might be used.

Term loan: You own a pizza restaurant and want to expand into a larger space that just became available next door. You also want to add two wood-burning pizza ovens so you can serve upscale, Neapolitan-style pizzas (and charge more). The expansion and shift in positioning will take a while to pay off, and the pizza ovens have a usable life of 10 years. Therefore, it’s to your advantage to stretch out the repayment to a long-term loan of 10 years.

Business line of credit: You own a landscaping business and have just completed several projects. You have a huge chunk of receivables due in a week, but you need to make payroll for your 20 employees in two days, and don’t have the cash on hand. You could use the line of credit to cover payroll, then pay it back as soon as your receivables come in.

“Be sure not to tie up your business equity line of credit paying for long-term investments, or you won’t have access to it in an emergency, limiting your flexibility – which is the whole point of a line of credit,” says Lesonsky.

The bottom line for both types of loans, and for big and small business, is to find a lender that has experience in matching businesses with financing sources. Look for a lender with flexible terms and competitive rates, and you’ll find the perfect type of loan for your business.