At some point, your business may find itself in need of a business line of credit.
When this happens, you want to make sure you find and enter into partnership with a lender you trust and who is a good match with your company values.
Let’s look at the steps you should take to responsibly initiate a line of credit for your family business.
What is a business line of credit?
You can think of a business line of credit much like you would a credit card.
With a line of credit, your lender allows you to borrow up to a prescribed limit – and you only pay interest on the amount of credit you use.
You can repay what you’ve borrowed and continue to draw credit against your set amount, and you can do this as often as you need to, as long as you don’t exceed your overall credit limit.
How does a line of credit differ from a business loan?
The option of using only a portion of your borrowed amount distinguishes a business line of credit from a traditional small-business loan and makes it a more flexible form of financing.
With a loan, you receive a cash amount as one lump sum and then repay it, plus interest, over a specific period of time.
You can access either a secured or unsecured business line of credit.
With a secured line of credit, you’ll be required to put up assets as collateral – such as your accounts receivable, inventory or your other business property.
With an unsecured line, you won’t need collateral, but your lender may insist on a personal guarantee or a lien on your business’s assets.
Why does your family business need a business line of credit?
A business line of credit can be used for many different types of expenses, ranging from financing the working capital needed for increasing sales and accounts receivable, buying inventory and managing volatile cashflow to helping cover payroll.
A line of credit may be a good option for businesses that experience seasonal ups and downs that influence cashflow, or whose owners want to have a cash reserve in case of unexpected expenses.
In some cases, like startup companies, a business line of credit also may be easier to qualify for since its credit requirements tend to be more lenient than those for a business loan. For newer businesses, a line of credit also helps build a relationship with a lender, along with establishing a business credit history.
Five tips for setting up your business line of credit
Below we’ve outlined five essential steps for setting up a business line of credit to best serve your organization.
1. Make a forecast
Pull together a two- to five-year forward-looking cash flow and balance sheet forecast.
Your forecast should include assumptions for interest rates and percentage borrowing base, if applicable, advance variables.
This exercise helps you articulate the funding needs that will determine your loan request, along with the resulting critical debt ratios.
2. Assess Your Collateral
Determine your potential collateral’s credit quality, including accounts receivable, inventory, marketable securities, personal guaranty, asset liquidity, etc.
These are the assets that will secure your line of credit and serve as the focus of your lender’s credit risk assessment.
3. Do some preliminary outreach
Give some thought to whether you will want to work with a lender who has specialized industry banking or other finance experience.
Once you’ve decided on your pool of potential lenders, reach out to them to find out whether they’re taking new clients and would be interested in responding to a request for a proposed term sheet.
During these preliminary discussions, you also can verify potential lenders’ experience and find out how long they typically take to complete the due diligence associated with application review.
As you talk with potential lenders, prepare a scorecard that allows you to record your feedback on the following factors: funding amount, loan term, loan pricing, including the unused LOC rate, advance rate percentage of the borrowing base, loan administration and reporting costs, credentials and banking treasury management, and other services.
Use your scorecard to calculate weighted averages – this will allow you to generate a single, quantitative score for each potential lender rather than relying on subjective criteria.
4. Make your request
Prepare a formal Request for Proposal and share with your top potential lenders. Provide the following information as part of your RFP:
- Business summary, including your business model and its go-to-market strategy
- Your most significant customer base
- Your primary business competitors
- Names/bios for owner(s) and management leaders
- At least two years’ historical financial statements
- Interim current year financial statement
- Forward-looking forecast
- Current accounts receivable and inventory aging schedule
- Two years’ federal tax compliance reports
- Corporate organizational chart that includes affiliated companies, proposed RFP submission date, expected bank selection completion date and primary contact person for questions
5. Conduct interviews
Meet with representatives from each of your potential lenders and ask questions regarding their services, industry experience and schedule alignment to confirm whether they would be a good cultural fit with your management team.
Continue scoring potential lenders on the scorecard you developed to help you make an objective decision.
Choosing a lender for a business line of credit can feel daunting, but with the right process – and the right partners – in place, it’s possible to smoothly find the lending institution that’s right for you.
If you’d like some support securing a business line of credit, please reach out today to schedule a call with one of our experienced family business advisors. We’d love to help.