Don’t Make a Mistake Financing Your Business

Need money for your business? Here’s how to evaluate whether a credit line or term loan is right for you.

If finding the right loan to finance your business seems overwhelming, if you have ever been denied by a bank for funding, or if you didn’t receive the amount of funding you needed, then join the club. Seeking bank loans is necessary and important to running and growing your business, but understanding the differences in loan options can be daunting.

You may be debating whether a credit line or a term loan is your best option for funding your business. If you are, you’re already ahead of the game! When we work with our clients to secure funds for their commercial real estate deals, we find that most business owners haven’t really thought through whether a credit line or a term loan is better aligned with their overall business goals and strategies.

Credit lines and term loans both serve a different purpose and each can help move your business forward. There is a simple way to view your options – credit lines meet short-term goals, while term loans reach long-term goals.  Understanding the differences in each will help you make a better decision for your business.

If you’re not sure which is right for you, read on to discover whether you can most benefit from a credit line or term loan.

Credit Line

Think of a business credit line much like a personal credit card that you reapply for each year. You have access to a set amount and up to a specific limit. You don’t make payments or incur interest until you use the funds. The credit line is something you can tap into again and again as long as you haven’t reached your limit. It’s similar to using a credit card with a specific funding limit – you use the funds as you need them and pay it back quickly. A credit line typically has a lower interest rate than a traditional business loan; however, if you’re late with payments or go over your limit, penalties can be substantial and costly.

The credit line is the most common choice because it’s often the easiest to get. This option is best used for short-term purposes or when you’re in need of cash fast. For example, if you need $100k to bridge receivables and payables or if you’re short on payroll, this is a great option. Think of the credit line as a backup or a cushion in those “just in case I need it” situations so apply for it when you don’t need it. Something to be aware of is under certain credit lines, the interest rate can fluctuate. This can be a big disadvantage – especially if you are using it in a situation where you can’t really afford any fluctuations.

Term Loan

Much like a personal home or car loan, the term loan is a lump sum of money you borrow and pay back over an extended period with interest. A term loan locks you into a fixed amount with, typically, a fixed rate. Unlike the credit line, this loan is not revolving. Once you use all the loan funds that is it. For this reason, term loans are best used to reach long-term goals, like expanding your business into a larger space. The term loan is also great for commercial real estate investments where you won’t necessarily see dividends quickly.

One thing to keep in mind is that the longer you’ve been in business or have had an established relationship with the bank, the easier it is to get a term loan.  Banks want to see a proven track record, so apply for a loan or line of credit when you don’t need it. Taking out a loan and paying it back on time will establish a relationship with your bank, plus it will demonstrate that you can pay back the bank. Doing this will increase the likelihood of you getting a loan when you need it most.

For either type of credit, you need to evaluate:

  • Your goals – Understand your business goals and strategies to help you decide the best loan option for your business. Make financial decisions that align and advance your overall business strategy. You can gain significant operational and financial advantages by taking a strategic approach.
  • Timing– Analyze your business objectives to help you determine whether you need the loan for the short-term or long-term. It’s important to understand the trade-offs experienced with each decision, then go with the one that best fits your strategy and goals.
  • Comfort with fluctuation – Ask yourself what kind of interest rate structure you are most comfortable with. This will depend on your current financial situation and overall business goals. Understand your comfort level will help you secure the rate that’s right for your business during bank negotiations.

Consider the big picture when deciding on the type of credit you need to start or grow your business. Be sure you have access to emergency funds for needs such as payroll, unexpected expenses, or temporary cash flow shortages. Evaluate your goals, timing, and comfort level with interest fluctuation. Increase your ability to obtain capital through term loans for long-term investments, such as commercial real estate, by establishing a relationship and demonstrating proven track record with your bank.

If you need more advice on funding your next commercial real estate deal, let us help you. Contact Verity to speak with an experienced real estate advisor.