Business Line of Credit vs. Loan: Making the Right Choose

One of the most prominent challenges businesses face is keeping their cash flow consistent throughout the year. Many businesses have seasonal cash flow, meaning they’re profitable some times of the year and lose money gradually in other months. 

Fortunately, business financing is available to help companies experiencing a financial shortfall. Two of the most common business financing options are a business line of credit and a small business loan. 

But what exactly are these options? And how do you know which one is right for you?

In this guide, we’ll answer all your questions concerning business lines of credit vs. small business loans so you can make the most informed decision. 

Defining Business Lines of Credit

A business line of credit is an extension of funds provided by a financial institution. These financial institutions are usually banks, credit unions, angel investors, and personal online lenders. 

A business line of credit works similar to a credit card. The lender agrees to give you a sum of cash with a limit. You can only spend the money within this limit. Also, you’ll be required to pay this money back over time. 

For example, let’s say that a bank gives you a $50,000 business line of credit. This funding means you have $50,000 of working capital to spend on payroll, overhead expenses, and other operating costs. 

You can’t exceed this limit, and the bank may request you sign a Personal Guarantee. If you fall behind on your payments and default, they can file a Uniform Commercial Code (UCC) lien on your business. 

And that is how a business line of credit works in a nutshell. Now, let’s go over more features of this lending option so you can determine if it’s your best choice. 

Who is This For?

A business line of credit is ideal for businesses that need short-term capital to stay operational in slow seasons. Since a line of credit is smaller than loans, they’re unsuitable for undertaking large business projects. 

It’s also easier to apply for a business line of credit, and the terms may be more generous for small businesses with limited cash flow. If you have a low-risk tolerance and simply need the funds to continue doing business, taking out a business line of credit may be your best option. 

Pros and Cons:

A business line of credit isn’t for everyone. Here are the key pros and cons you can expect if you’re approved. 

Pros:

• A line of credit can cover practically any business expense. The lender will essentially give you carte blanche to spend as you please until you reach your credit limit. 
• Some lines of credit are unsecured. You won’t need to offer any collateral to apply, which is a win-win situation if you lack substantial financial resources or have bad credit. 

Cons:

• Lines of credit are almost always smaller than business loans. 
• You may have to pay additional fees, such as inactivity, draw, and annual fees. 
• If your account becomes delinquent, your lender may file a lien against your business. 

Ultimately, you should consult these pros and cons before taking out a line of credit for your business. 

Small Business Loans: A Closer Look

A small business loan is a lump sum given to a business by a lender. Like a business line of credit, banks, credit unions, angel investors, and personal online lenders can finance small business loans. 

When you take out these short-term loans, you agree to receive a sum of cash and pay it back with interest. Business loans are usually larger than lines of credit. 

When you’re approved for a small business loan, you’ll receive the entirety of the loan upfront, like a personal loan. Also, collateral is usually required to give the lender security against a potential default on your part. 

Finally, you’ll be required to pay interest on the amount of money in the end. This repayment is how the lender will make their money back with a profit. 

There are many types of business loans. The two most common are Small Business Administration (SBA) loans and term loans. 

An SBA loan is provided by the Small Business Administration. These loans are known for having lower interest rates, low down payment requirements, and flexible eligibility standards for small businesses and startups. 

On the other hand, a term loan is a standard business loan with a fixed interest rate and repayment schedule. Borrowers will need to pay a business term loan back within a specific time frame, varying from one to 30 years. 

Who is This For?

A small business loan can fund any major transaction a business needs to grow. For example, if you’re undertaking a new product launch or planning an acquisition, securing bank loans may be ideal. 

Since small business loans are larger than lines of credit, they’re suitable for substantial business expenses. However, these loans come with interest that can vary depending on your business credit score, credit history, annual revenue, and years (or months) you’ve been in business. 

For this reason, taking out a small business loan may not be ideal if you need to cover a cash flow shortage and solely pay your overhead expenses. 

Pros and Cons

Small business loans can be used for a variety of business opportunities. Before applying, you should closely assess these pros and cons:

Pros:

• You can typically borrow a higher loan amount from a small business loan than a line of credit. 
• Most of the time, you’ll get all of your capital upfront after approval. 
• Some lenders offer same-day financing, meaning you’ll get your funds directly into your checking account within a couple of hours.
  

Cons:

• To secure a business loan, you’ll generally need collateral, such as cash savings, real estate, or inventory. 
• This type of financing can only be used for a specific purpose. For example, if you apply for equipment financing, you can’t use this funding for payroll. Conditions will vary based on your lender. 

As you can see, small business loans come with its fair share of caveats. Let’s explore how they’re different from lines of credit. 

Key Differences Between Business Lines of Credit vs. Loans

Small business loans and business lines of credit differ in several ways, such as:

• Purpose and use cases: A business line of credit can be used for any purchase, whereas other types of small business loans can have very specific underwriting requirements. This flexibility means that a business line of credit can cover situations such as short-term cash flow gaps or unexpected expenses or take advantage of timely business opportunities. 
• Repayment terms and structure: A small business loan is repaid with interest through monthly payments. A line of credit accrues interest the moment you draw from it. Generally speaking, a business loan has a repayment schedule, while a line of credit is like a business credit card. 
• Interest rates and fees: Both lines of credit and business loans have interest rates and fees. Both will depend on your lender as well as your credit profile. 
• Accessibility and application process: The application process for a business line of credit and an SBA loan are fundamentally similar, with small business owners and entrepreneurs providing financial documents and details about their businesses. The key difference lies in the more stringent requirements that come with applying for an SBA loan. Despite this stringency, many businesses opt for lines of credit due to their greater flexibility and the autonomy to manage their funding.
• Flexibility and ongoing availability: A line of credit provides a revolving door of capital. You receive a limit and have complete control over your spending decisions therein. However, a small business loan is fixed. You’ll receive a predetermined amount, either weekly or monthly, that is used to meet specific business needs, such as equipment financing. 

Now that we’ve covered the differences between lines of credit and small business loans, let’s discuss how to decide which is right for you. 

Making the Right Choice for Your Business

There is no definite answer on which lending option is better. Choosing the right business funding option ultimately depends on your business goals, creditworthiness, and financial projections. 

If you want to fund your ongoing business expenses, a line of credit may be the most suitable option. However, if you want to finance a large business undertaking, taking out a small business loan may be your best option. 

Whichever You Choose, Rely On SBG Funding for Financing

Overall, a business line of credit and a small business loan are excellent ways to receive the working capital needed to run a successful business. 
The good news is that SBG Funding offers both loan options to suit your business needs. Ready to get the funding you need? Start the application process and grow your business.