Business line of credit: borrow what you need, when you need it

A business line of credit is a set limit you can draw from, repay and draw again, paying interest only on what you have used. It is built for gaps you can't time: a slow month, a late-paying customer, a supplier who wants paying before you've been paid. For recurring, unpredictable needs it is usually cheaper than taking a lump sum you don't fully use.

How it works

The lender sets a limit, say $100,000. You draw $30,000 when payroll lands before a big invoice is paid. You pay interest on $30,000 until you repay it. The other $70,000 sits there costing nothing, or a small fee, until you need it.

There are two main types:

• Revolving. Repay what you drew and it's available again. This is the classic line of credit.
• Non-revolving. Each draw reduces the limit permanently. It works more like a loan you take in pieces.

Repayment varies. Some lines want interest only for a period and then the principal; many online lines turn each draw into a short installment loan, repaid weekly or monthly over a set number of months.

How the cost works

A line of credit can carry three kinds of charge:

1. Interest on drawn balances, quoted as an annual rate.
2. Draw fees each time you take money out.
3. Maintenance or annual fees for keeping the line open, whether you use it or not.

Here's the maths on one draw, with an assumed rate. If you draw $50,000 at 30% APR and repay it in 6 monthly payments, each payment is $9,077.50, you repay $54,464.99, and the interest is $4,464.99. Repay weekly over the same 6 months and it's 26 payments of $2,076.44 and $3,987.54 of interest, because principal comes down sooner.

Compare a $50,000 merchant cash advance at a 1.2 factor over 6 months: $60,000 back, a $10,000 cost and about 75% APR. Even at 30% the line costs less than half as much on this need, and if you repay early you save interest, which an advance rarely lets you do.

The 30% is an assumption for illustration, not a quote. Put your own offer into the loan payment calculator to see the payment and total cost.

Fees change the picture. A draw fee taken from each draw means you receive less than you borrowed, which raises the true cost. If you draw small amounts often, add up the fees for a year and divide by what you actually used.

California requires providers of commercial open-end credit plans, as well as loans and advances, to disclose the total dollar cost and the payment terms on offers of $500,000 or less. Wherever you are, ask for the cost of a typical draw in writing.

Using a line well

A line of credit works best with a little discipline:

• Draw for a reason with an end date. Know which receipt repays each draw before you take it.
• Repay as soon as the money comes in. Interest runs daily on most lines, so a draw cleared in three weeks costs a fraction of one left for six months.
• Watch the renewal date. Many lines are reviewed each year. Send updated statements before the review, not after a bad quarter.
• Don't let it become permanent. If the balance hasn't come down in a year, move it to a term loan with a fixed end date and keep the line free for the next gap.

Who it suits

• Businesses with gaps that recur but don't follow a calendar: service firms waiting on slow-paying clients, wholesalers with lumpy orders, retailers restocking between seasons.
• Owners who want a safety net they may not use.
• Anyone who expects to repay quickly. A line rewards short, repaid draws.

Who it doesn't suit

• A one-off, defined purchase. A term loan or equipment financing is simpler and usually priced better for that.
• A business that will draw the full limit and never bring it down. That is a term loan in disguise, often with worse terms.
• A business whose deposits are falling. Lines are reviewed, and a limit can shrink just when you need it.

What lenders look at

• Revenue and deposits, usually from recent bank statements and often tax returns or financial statements for larger lines.
• Time in business and profitability.
• Personal and business credit. Lines tend to lean on credit more than advances do.
• Existing debt. A lender wants to see room in your cash flow for repayments on a full draw.
• Collateral. Larger lines may be secured on receivables, inventory or a general lien on business assets, and most ask for a personal guarantee.

Red flags

• A fee schedule that isn't attached to the offer.
• A "line" where every draw comes with a fixed factor-rate payback. That is an advance in a line's clothing; price it with the MCA APR calculator.
• No clear terms on when the lender can freeze or reduce the line.
• A required minimum draw.
• Pressure to draw the full limit on day one.

Sterling's take: a line of credit you never draw on is the cheapest money you'll ever arrange. Get it while your numbers look good, not when you need it.

How it compares

For more on the short-term options, see working capital financing.