Loans and Lines of Credit As a Way to Fund Start-Ups and Existing Small Businesses

Starting and growing a small business can be very difficult.

However, with proper planning and preparation, it can be done successfully. As a future or existing business owner, one of the keys to success is to use all of the resources available to you. This includes loans and investments from family, friends and angel investors. It also includes loans and lines of credit from a bank, which are resources that many entrepreneurs fail to consider as a viable option for starting or helping to grow their business.

If you listen to any news outlet with a business segment or financial focus, you will definitely get the message that the amount of capital available for entrepreneurs starting small businesses has shrunk. It is true that as a result of the most recent recession, lending institutions have tightened up the qualifications for lending money to business owners. However, there are still funds available to help entrepreneurs achieve their financial goals. “In the U.S. alone, there are an estimated 27.5 million small businesses. And nearly 80 percent of them get their money through bank loans, credit cards and lines of credit.” (Julian Hills) The key is that as a business owner, you cannot be afraid to pursue the financing required for your business.

There are several options available to business owners for financing their business. However, we will focus on loans, lines of credit and SBA guaranties. A term loan is often used as a way to pay for a major investment in the business or acquisition. Term loans often have fixed interest rates, with monthly or quarterly repayment schedules, a set maturity date and usually require collateral to secure the loan. A term loan is best used to finance the acquisition of a business, equipment or real estate purchase.

“A Line of credit is a simple financing product that allows you to withdraw funds up to a predetermined amount.” (Marco Terry) With a line of credit, you are only required to pay interest on the outstanding balance, usually on a monthly basis. However, principal reductions should be made regularly, if not monthly. Lines of credit are very flexible and unlike term debt, can be used for more than one purpose, such as paying suppliers and covering operating expenses. Lines of credit can also be used to cover gaps in cash flow from operations, which can be very beneficial for business owners, especially those in the start-up or growth stage of their business.

The challenge is that lines of credit are very risky to banks. If the line is not used properly, it may have to be termed out and repaid by principal and interest payments for a fixed period of time. Therefore, most lines of credit, especially those for businesses still in the start-up stage require hard collateral. This consists of liquid collateral, such as CD’s and brokerage accounts, equipment, or a lien on real estate. Banks prefer that lines of credit are fully secured by collateral. However, in the event that there is a shortfall in hard collateral, there are ways in which the bank can still provide financing to start-up businesses while protecting its investment. One of those ways includes obtaining a SBA guarantee.

SBA (Small Business Administration) is a government agency that provides a variety of services to small business owners. One of the services they are known the most for is providing guaranties on small business loans. This is done in partnership with financial institutions that provide financing to small businesses. Although SBA doesn’t loan money directly, it does set guidelines for loans made by financial institutions. It is important to note that business owners must be able to qualify for loans with commercial banks contingent upon obtaining the SBA guaranty in order to qualify for an SBA loan. The major benefits of obtaining a SBA loan are loans structured with longer terms, lower down payments, lower interest rates, and less collateral than conventional loans. Some of the challenges of SBA guaranteed loans is that they require more paperwork and time than conventional loans.