What is a Line of Credit?

By: Micah

A line of credit is the best version of working capital.  Term loans are only good for specific business purposes and purchases.

Let’s first talk about the amounts.  While a term loan offers higher amounts and perhaps a longer term and therefore lower monthly payments, it’s so much debt up-front that who knows what type of money will be needed right away.

With a line of credit, it’s not about the money up-front or the exact payback term, it’s about having access to the capital over a period of time you need it. Many borrowers are so nervous they won’t have access to the money unless they get it up-front…. A LOC is always better, even if the APR is higher, since they don’t pay for what they don’t need.

There are a few aspects to classic lines of credit.
Aspect 1) Any funds paid down can be withdrawn (“revolving”)
Aspect 2) It sits there until you need it and you do not pay on unused funds
Aspect 3) Pay any of it down whenever you want / No Prepayment Penalty

With regards to Aspect 3: Some term loans have this, like an SBA; but most mortgages and with Merchant Cash Advances, you have to pay either some or all of the payback amount, or like in mortgages, it takes 3-5 years there’s no more prepayment penalties.

There are lenders who offer a combo of Aspect 1 and 2.  They have an aggressive pre-payment discount, so it’s not a “classic” Line of Credit vis-a-vie Aspect #3.  As far as business credit, even for the credit-challenged, if the cash-flow is good, there a few classic Lines of Credit that has all 3 aspects.

Invoice factoring and invoice financing, depending on the lender, if it’s not a true asset-based line of credit, there will very often be an obligation to factor all of the receivables through the factor, so it’s not really covering Aspect 2, but it is Aspect 1 and Aspect 3.

There are many ways for your business to qualify for some combination of the above, so please drop us a line to discuss!

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