Defined as any credit source for a business, a business line of credit allows a company to use the capital gained to grow the business and take advantage of opportunities as they arise.
An unsecured business line of credit requires no collateral, though it often comes with a higher interest rate.
Unsecured business lines of credit
Many lending institutions extend a line of credit in the form of a loan, with approval dependent on the type of unsecured business line of credit sought. The following represent the two main types of unsecured business lines of credit:
- Traditional: A traditional unsecured business line of credit requires a large amount of documentation by the business. Some of the common forms of documentation required include personal tax returns, business tax returns, any bank account information for the business and any documentation used in the registration of your business. Businesses also must complete an annual review to maintain the traditional line of unsecured credit.
- Nontraditional: Nontraditional unsecured business lines of credit include credit cards in the business’ name. A business credit card gives a company fast access to the money it needs and payment flexibility. Qualification for a nontraditional unsecured business line of credit is based on your business’ FICO score, requires much less documentation and does not require a yearly review.
Secured vs. unsecured line of credit
Collateral, or the lack thereof, represents the main difference between a secured and unsecured business line of credit.
Unlike a secured line of credit, an unsecured line does not require the business to put up any collateral. The creditworthiness of the business applying for the unsecured line of credit plays a big part in determining whether the business qualifies for an unsecured line of credit.
Many newer businesses might only qualify for a small loan at first until they establish a positive credit history. Line of credit amounts depend in large part on factors such as the business’ revenue, expenses and age.
Pros and cons of an unsecured business line of credit
An unsecured business line of credit presents advantages and disadvantages. For advantages, the unsecured business line of credit provides a quick way for a business to obtain cash, as long as it meets the requirements.
An unsecured line of credit also protects your business if you need to default on the loan for whatever reason, except in the case of a court order. Advantages also apply to bankruptcies, with the court usually discharging unsecured loans.
The disadvantages of an unsecured business line of credit include higher interest rates and more stringent qualifications. As long as you can meet the requirements of applying for an unsecured business line of credit, most lenders should approve you for an unsecured loan.
Requirements to qualify for a business line of credit
To qualify for an unsecured business line of credit, a business must meet certain requirements. If a business fails to meet criteria in one or more of these areas, they can still get a secured line of credit.
A good FICO score and overall business credit score represents primary determining factors when applying for an unsecured business line of credit.
Considerations that go into a business credit report include applications for loans and loan payment history.
Ranging from zero to 100, a business credit score also takes into account any business-to-business credit. The creditworthiness of a business determines the type of loan you can apply for, with scores of 75 or more considered excellent.
A low score does not mean you cannot get a line of credit, only that you might have to secure it with collateral.
An open bank account in good standing represents one of the main requirements of a business applying for an unsecured business line of credit.
In addition to the overall status of the account, lenders also look at the average daily balance of the account. Lenders tend to look negatively at businesses that frequently overdraw the account or bounce checks.
Lenders prefer business accounts with a positive cash flow, as this factor helps assure lenders that the business regularly shows a profit, making them a better investment.
Many lenders require businesses applying for an unsecured business line of credit to show a financial history of two or more years. This helps ensure to the lender that the business in question can continue operating in the future without folding.
Businesses can prove financial history by providing income tax returns, banking documents and financial statements.
Business owners need more than a business plan and employees. They also need the working capital that an unsecured business line of credit provides.
Knowing the necessary requirements lets the business apply for an unsecured business line of credit with confidence, allowing it to grow and take advantage of opportunities when they present themselves.