12 Times It Makes Sense to Take out a Small Business Loan or Tap a Line of Credit
Know which one is better for your circumstances.
Running a small business is never easy, but it can be especially tough if you’re scrambling for funds to cover your bases or attempting to grow without the necessary resources. Taking out a loan or a line of credit could be the answer. In the short term, you’ll gain access to funds to cover costs and allow for expansion; in the long term, you’ll build a credit history for your small business, should you need a larger loan in the future.
The need for working capital is the most common reason small business owners consider a small business loan or line of credit, according to Brandon Thomas, Small Business Relationship Manager at Cadence Bank. These additional funds can help cover a variety of costs, such as extra contract labor, extra inventory and even seasonal fluctuations in revenue.
In which business situations should you take out a loan, and which ones are better suited for a line of credit? Thomas explains each of these financing solutions and when it makes sense to leverage them.
What is the difference between a small business loan and a line of credit?
A small business loan has a structured term and normally features a fixed interest rate. If you want to secure a loan for $10,000 and pay it off in three years, your payments will be the same every month for three years. Once it is paid off, the loan closes itself out.
A small business line of credit involves a revolving line of credit. You can use the entire line or only part of it; you’ll only be charged interest on the amount of credit that has been used, and excess funds are available for use as needed. Once you pay back what was used, you can use it again. Any payment you make on the principal allows you to borrow again. "Think of it as a credit card with a better rate, but it doesn’t have a piece of plastic attached to it,” Thomas explains.
“Once we execute a loan for a customer, that rate is fixed for the life of the loan. If you’re someone who likes structure, that’s the way to go. With a line of credit, the rate can change as the prime rate increases—as the Feds raise or lower rates each year,” he says.
How to decide between a loan or a line of credit
It’s best to talk to someone like Thomas who specializes in working with small businesses. They can help you find the right option for your needs.
"As a small business relationship manager, when the customer comes to us and says ‘We want this,’ we’ll have an in-depth conversation with them,” explains Thomas. “Together, we figure out the best vehicle of loan or credit for them.”
Your small business relationship manager will ask you questions to understand your plans for paying a loan or line of credit back. “Are you going to be able to pay it off in the short term? If it is going to take you five years, then we may need to go the loan route,” he says.
“It also depends on what the funds would be used for; most banks won’t hand you a $1 million line of credit for a piece of property. Instead, we would recommend a business loan for a large purchase with a long-term payback structure,” Thomas says.
The following are Thomas’s recommendations for when it makes sense to go with each option.
Times it makes sense to take out a:
Small business loan
1. Buy more equipment
2. Purchase commercial real estate
Small business line of credit
3. Order capital during a slow season
4. Hire more staff, especially if your hiring is seasonal
5. Extend business hours, especially if your extension is seasonal
6. Stock up on inventory
7. Revamp your marketing efforts or your website to maximize sales
8. Cover upfront costs for big jobs/unexpected contracts. Having a reserved line of credit for unexpected contracts saves your own capital and enables cash flow for temporary purchases while keeping your capital in the bank for payroll, electricity, etc.
9. Emergencies. According to Thomas, "The best time for you to have a line of credit already set up is an emergency. Sometimes things occur that business owners can’t control. Having a business line of credit set up in advance helps when you need the money. If you're already in an emergency, it’s too late; you may not qualify due to your current emergency or cash flow situation. You may need it now, but it could take two weeks to release funds for a new line of credit.”
10. To build business credit. “It’s common to talk about this on the personal side a lot, but not as common on business,” Thomas says. “Just like if you were trying to buy a house, and a lender would check your personal credit, the same thing happens with business credit. Opening a line of credit, even a cash-secured line, is a great option to start building business credit in case you were to need a bigger, unsecured loan or line of credit.”
11. Upgrade old machinery. Whether you need a loan or line of credit will depend on the machinery or equipment; if you want to upgrade, add new parts or conduct maintenance, a line of credit would be better, because you never know the true total of maintenance costs until the work is completed. If you’re buying large facilities or machinery, a loan might be a better option.
12. Expand facilities. If you’re physically adding to the structure of your facilities, then a loan would be the better option. If you want to expand capacity through efforts like adding shelving to be able to store more, a line of credit would be more appropriate.
Choosing the right option for you
Once you have an in-depth conversation about your business needs with your small business banker, they will recommend one or more options to consider. Thomas reiterates how important it is to have a bank and an account manager that you trust and has your best interests at heart.
“At Cadence, our number one priority is having a long-lasting relationship with our clients and being the bank that clients can trust,” Thomas says. “When that happens, everyone—especially small business owners—wins.”
Would you like to learn more? Get in touch with a banker today.
This article is provided as a free service to you and is for general informational purposes only. Cadence Bank makes no representations or warranties as to the accuracy, completeness or timeliness of the content in the article. The article is not intended to provide legal, accounting or tax advice and should not be relied upon for such purposes.