Should You Use a Personal Line of Credit to Fund Your Business?
As a small business owner, you recognize the importance of having consistent cash flow to pay employees, cover costs and invest in projects to grow your business. Cash on hand is essential to managing your day-to-day activities smoothly and accomplishing your growth goals. This is especially true if you’re facing unfortunate situations like a late payment from a big client or the need to replace a piece of equipment.
What’s the best way to ensure that you have sufficient cash resources? Most business owners look to financing to achieve this goal. Financing can take many forms, including credit cards, loans from friends, an SBA loan, a line of credit, a bank loan, a loan from an alternative lender and merchant cash advances.
Lines of credit are a particularly attractive form of credit, because they allow you to borrow what you need (up to your credit limit), repay what you borrowed, and borrow again, paying interest only on the money you use. That makes lines of credit a great way to deal with cash flow problems. It’s also an effective way to manage working capital needs and take advantage of time-sensitive opportunities. Lines of credit give you the ability to handle emergencies and opportunities equally well. For example, you can use a credit line to:
- Purchase a new piece of equipment
- Open a new office
- Hire new employees
- Stock up on inventory for your busy season
Another benefit of using a credit line to support your business is that it may help build your business credit rating and position you for better loan terms in the future.
In this article we’ll talk about the advantages of using a line of credit to fund your business. We’ll also look at the pros and cons of using a personal line of credit to fund your business.
What is a line of credit?
A line of credit is an arrangement between a lender (typically a bank) and a borrower that gives a specific dollar amount that the borrower can pull funds from. With a line of credit, you can borrow funds at any time as long as you don’t exceed the maximum credit line amount. What makes this type of loan very desirable for business use is that it works like a revolving account — meaning that it can be borrowed against at any time without having to reapply.
Like a credit card account, you have a credit limit; you receive a monthly bill; and you have to make at least a minimum monthly payment. The good news with a line of credit is that you will only pay interest on your outstanding balance, not on the entire loan amount.
Lines of credit come in a variety of forms with variations in terms of their duration, grace periods, interest and draw fees, if any. It’s important to fully understand the terms of your specific line of credit before accepting an offer.
How does a line of credit work?
A line of credit works similar to a credit card. The line can be used when needed, and as you pay down your debt, your credit line is replenished up to the original credit limit.
With a line of credit, you can borrow funds at any time, as long as you don’t exceed the maximum credit line amount. For a small business owner, the largest advantage of a line of credit is its flexibility. You don’t have to use the total amount you’re approved for, which means you don’t have to pay the total amount back.
Your bank will tell you that you can use your line of credit for just about anything, and that is absolutely true. But, you should really use the money for something that is essential to your business and can be repaid quickly. Repaying your line of credit will enable you to draw on it again when you need it. In the best-case scenario, you will want to use a good percentage of your credit line to generate additional revenue to grow your business. Trade shows, for example, would be a great use of this type of funding. A trade show gives you brand exposure and the opportunity to build leads that can result in sales.
The pros and cons of a line of credit
Here are the pluses of having a line of credit:
- Flexible access to funds: With a personal line of credit, the borrower has access to the total limit of their loan throughout the draw period.
- Pay interest only on what you use: The big plus of a personal line of credit is that the borrower only owes interest on the money that they actually use from the loan.
- Reusable cash flow: Once you pay back the amount borrowed from a personal line of credit, the full amount becomes available to borrow again, within the remaining timeframe of the original loan.
Here are the cons:
- Potentially high interest rates: Because personal lines of credit are typically unsecured loans, they may come with higher interest rates than other similar products that require collateral.
- Additional fees: Lenders often charge annual or monthly maintenance fees on a personal line of credit. Be sure to check on these fees before signing up for a line of credit.
- Can be challenging to get: Because the personal line of credit is unsecured, most lenders require a high.
What’s the difference between a line of credit and a business loan?
With a term loan, the borrower gets the agreed upon amount all at once, and interest begins accruing immediately. A loan is non-revolving, meaning that you don’t get to draw from the capital more than once.
With a line of credit, the loan is revolving. The borrower can continuously and repeatedly access the funds for as long as the line of credit is active.
What’s the difference between a secured line of credit and an unsecured line of credit?
A secured business line of credit requires you to put up assets such as inventory or property. If you fail to pay back the credit line, a lender could seize your assets.
An unsecured business credit line doesn’t require collateral, but some lenders may still require a personal guarantee or a lien on a business’ assets.
Business line of credit vs. personal line of credit
While a small business line of credit is the best option for small businesses, for a number of reasons including your credit score and your financial history, some businesses aren’t able to qualify for this type of funding. Most lenders require businesses to have strong revenue and at least a few years of history to qualify for a line of credit.
For businesses who don’t qualify, they have another option: to use a personal line of credit for their business.
The key difference between a business line of credit and a personal line of credit is that the business line of credit is tied to your business, whereas the personal line of credit is tied to you as an individual.
The pros of using a personal line of credit
For a business owner trying to jump start his business, make it through a slump, or spur growth, you need to get some money injected into your business fast. Cash flow is critical to your long-term success. This is one of the benefits of this type of funding. It’s relatively quick. Many banks offer applications online and can have you approved and accessing your funds on the same business day.
Another benefit of using a personal line of credit instead of a business line of credit is that there is less red tape. Business lines of credit typically have more stringent requirements than personal lines.
Also, personal credit lines are usually free of application costs, annual fees, and pre-payment penalties.
The cons of using a personal line of credit to fund your business
Like oil and water, business and personal assets are really two things that don’t mix well.
That is is especially true if your business is a corporation. Using a personal line of credit for a corporation mixes personal and business assets. This could invalidate your corporate status.
If your business goes under, when you use a personal line of credit, your home and other assets could be at risk.
In addition, because personal lines of credit are unsecured, lenders can’t easily seize your assets if you fail to make your payments. So, they’ll charge more in interest than they would for a traditional secured loan, which includes a business line of credit.
How do you qualify for a business line of credit?
Lenders typically require the following documentation: personal and business tax returns, bank account information and business financial statements, including profit and loss statements and a balance sheet. Most lenders require you to have been in business for at least six months and have a minimum of $25,000 in annual revenue.
Online lenders typically have less stringent qualifications than banks. However, these lenders are likely to charge higher rates than banks and may have lower credit limits.
Getting a business line of credit from Kabbage
At Kabbage, we don’t offer personal lines of credit. But you can get approved for a business line of credit in 10 minutes or less. We use an online, automated application, which allows you to conveniently connect Kabbage to your accounting software or bank account. In a matter of minutes, we can analyze your information and let you know if you’ve been approved, how much funding you can access, and what your rate will be.
Once you are accepted, you will get three choices for using your capital: PayPal funds (usable immediately), direct deposit (accessible the next day) or a Kabbage card (takes a few days to get, but then works a lot like a debit card).
What should you do once your business line of credit becomes active?
If you have immediate needs for cash that will support the growth of your business, use your line-of-credit funds immediately. If you don’t have immediate needs, you don’t need to worry. You don’t have to start paying anything back until you actually borrow funds.
What is required to obtain a business line of credit?
Each lender has the right to choose its own criteria for determining whether you qualify for their business line of credit. Most lenders will want to see financial records and documents that demonstrate a business track record and creditworthiness.
Should you use a personal line of credit to fund your business?
It would be better to use a business line of credit to fund your business. If this isn’t available to you, you can consider using a personal line of credit. But be mindful of the drawbacks associated with this type of funding.
What Should I Use a Personal Credit Line For?
There are, of course, the things that you want to use your credit line for, and things that you should use your credit line for. Your bank will tell you then you can use it for just about anything, and that is absolutely true. Once you have the line established, what you use it for is your business as long as you pay the money back.
But, if you are risking your personal credit score for your business, you should really use the money for something that is one, essential, and two, can be repaid quickly. You want to be able to get your line repaid quickly so it is fully funded and ready to be drawn on again when you need it. In the best-case scenario, you should be drawing money to use on revenue-generating activities (RGA). Make sure a good percentage of that credit line is used to generate additional revenue to grow your business. Reason being, you need more money to pay back that money! It is absolutely true that it takes money to make money.
Make good use of the money when you draw it. Have you wanted to spend a little more on marketing activities, or a television or radio ad campaign? Your credit line would be perfect for that. Additional marketing and advertising can bring your opportunities and clients like you never had before, and marketing is one of the activities that many businesses skimp on when times are tough.
Another short-term effort that offers a high rate of return is participating in trade shows. Again, you are building your brand exposure and developing key relationships. Although the cost of being in a trade show is high, the rewards could really help your business take off! Good thing that the costs of participating in and traveling to trade shows can definitely be paid for with your credit line! Other wins for using your line would be some putting in place some long-term efforts to help your business. It would be the perfect time to review and build your brand with the help of an agency or jump into the social media arena. Both will take some time and money but are great for business.
Of course, there will be some hiccups for your business along the way, and you may need immediate access to funds. Maybe someone was slow to pay your business this month and you can’t make payroll. It’s critical you pay your employees, so drawing on your line of credit is perfectly acceptable! Just be sure to go after that slow paying customer and pay yourself back when you get the money. And of course every business will have peaks and valleys. Your credit line is perfect to help you in the slow months. You may not want to exhaust funds that your business has for the month for additional inventory or a higher than normal bill, you line will give you the breathing room that you need.
For new business owners that are starting out, another example would be to give yourself a small salary for a few months while you transition into a more full-time role in the business or to pay yourself back from monies you already spent on the business. The first months and years of a business are difficult, and you may be working multiple jobs to make ends meet. Use your credit line to help you jump feet first, and be 100% vested in making your business work.
Your personal credit is an asset to you and to your business, don’t make it a liability. It truly is an asset, preserve it and maintain it – and use it the proper way. Revolving credit can be a benefit to business owners in many ways when it’s used within certain contexts and for a specific purpose. But there are also many ways that the flexibility of “buy now and pay later” can trap business owners and take a toll on your personal credit and potentially your life. Revolving credit must be used wisely, and as a business owner, you need to have knowledge of how a line of credit works and the risks associated with this type of personal financing.
A personal line of credit is much like any financial product – neither inherently good nor bad, it all comes down to how you actually use them. Any amount of excessive borrowing against your line can get you into the same amount of financial woes as borrowing with credit cards, or taking out a loan you really can’t afford (although the banks says you can). A line of credit can also be very cost-effective solution to month-to-month financial fluctuations or helping to fund a large or complicated transaction such as a new product or office remodeling. As is the case with any loan, you should always pay careful attention to the terms and details including the fees, interest rates and repayment schedule. So, shop around and don’t be afraid to ask plenty of questions before signing on the dotted line.