How startups can get a business line of credit

What are business lines of credit, and how do they work?

A small business line of credit is a revolving credit option that lets you borrow up to a set limit, repay the borrowed amount, and access additional credit as needed. It is commonly offered by credit unions, banks, and online lenders as a short-term business financing option.

Unlike a term loan, which gives you a lump sum with fixed repayment terms, a line of credit gives you the flexibility to hold onto funds within your business checking account whenever you need them.

How does a business line of credit work?

A business line of credit functions similarly to a credit card but offers higher limits and lower interest rates. You can get access to funds up to your approved credit limit, and as you repay, your available balance replenishes.

There are two types of business lines of credit:

• Secured business line of credit: This requires collateral (business assets like real estate, equipment, or inventory) to reduce the lender's risk.
• Unsecured business line of credit: This doesn’t require collateral but may have higher interest rates because of increased risk for the lender.

Business line of credit vs. term loan

While both provide funding, they serve different needs:

• Repayment terms: A term loan has fixed monthly payments over a set period, while a credit line remains open, allowing you to borrow and repay multiple times.
• Flexibility: Term loans provide a lump sum, often for a specific expense. A credit line gives you ongoing access to funds for various needs.
• Cost: Term loans generally have lower interest rates, while lines of credit provide more flexibility at higher interest rates and fees. 

Key takeaways

• A business line of credit is a flexible startup business funding option that allows repeated borrowing and repayment.
• It can be secured (requiring credit line collateral) or unsecured (no collateral but higher interest rates).
• It differs from a term loan in repayment structure, flexibility, and cost.
• Business lines of credit require monthly payments, but there are no penalties for early repayment.

Secured vs. unsecured credit lines: Key considerations for startups

The right choice for a business line of credit depends on your startup’s financial situation, risk tolerance, and borrowing needs. Here’s how they compare and which one may work best for early-stage startups.

Secured line of credit

A secured line of credit requires collateral (assets like property, inventory, or equipment) that the lender would seize if you fail to repay the loan.

Key features:

• Lower interest rates: Since lenders have security, they charge competitive rates.
• Higher borrowing limits: The amount of funds you can borrow based on the value of your collateral.
• Easier approval: If you have a limited business credit history, offering assets improves your chances of getting approved.

Unsecured line of credit

An unsecured line of credit doesn’t need any collateral, but approval depends on your creditworthiness (credit reports, business revenue, and financial stability).

Key features:

• No asset risk: You don’t have to pledge property or inventory.
• Higher interest rates: Lenders charge more since they take on greater risk.
• Lower borrowing limits: Without collateral, lenders may limit how much you can borrow.
• Stricter eligibility criteria: Startups with little to no financial history may find it harder to qualify.

Which option is better for early-stage startups?

• If you own valuable assets, a secured line of credit may offer lower costs and higher limits.
• If you lack collateral but have a strong credit score, an unsecured line of credit can provide business financing without risking assets.
• If your credit history is limited, you may need to start with a secured credit line until you build trust with lenders.

Key takeaways

• Secured credit lines require collateral, have lower interest rates, and are easier to get if you have assets.
• Unsecured credit lines don’t require collateral but have higher interest rates and are difficult to qualify for if you lack a strong credit history.
• Startups with assets may benefit from secured credit, while those with strong credit and steady revenue may consider unsecured options.

How to qualify and choose the right credit line

How to qualify for a business line of credit

A business line of credit provides flexible access to funds, but qualifying for one depends on factors like credit score, revenue, and business history. Here's what you need to know to secure the right financing for your startup.

Step 1: Strengthen your qualifications

Before applying, take these concrete steps to improve your chances of approval:

1. Check and improve your credit score
   
   • Pull your personal and business credit reports
   • Dispute any errors you find
   • Pay down existing debts to lower your utilization ratio
   • Maintain on-time payments for at least 6-12 months
2. Organize your financial documentation
   
   • Prepare the last 3-6 months of bank statements
   • Gather tax returns for the past 1-2 years
   • Create a profit and loss statement
   • Compile a list of business assets for potential collateral
3. Establish business legitimacy
   
   • Ensure all business licenses and registrations are current
   • Verify your business has a separate phone number and address
   • Create or update your business website and social profiles
   • Establish trade credit relationships with suppliers

Step 2: Understand qualification requirements

Most lenders evaluate three key factors when deciding whether to approve your credit application:

1. Credit score

Lenders generally require a personal credit score of 670 or higher, though some may approve lower scores in exchange for higher interest rates. 

Having a strong business credit score also improves approval chances. If your small business doesn’t have an established credit history, you can use a business credit card responsibly to build one. Any past defaults on small business loans or late payments may reduce eligibility.

2. Business age

Traditional banks prefer businesses that have been operating for at least one year, as it demonstrates stability. Some online lenders are more flexible and may approve younger businesses, but they often charge higher interest rates to offset the risk.

3. Revenue and cash flow

Many banks require at least $100,000 in annual revenue, while some online lenders may accept businesses earning as little as $25,000. 

Consistent revenue streams indicate a business's ability to repay borrowed funds. Fluctuating or unpredictable cash flow can make lenders hesitant to extend credit.

Special considerations for early-stage startups

For startups with limited operating history or inconsistent revenue, traditional credit lines may be difficult to secure. In these cases, consider these alternatives:

• Corporate card solutions with alternative underwriting: Services like Rho offer corporate cards based on factors beyond traditional credit history, looking at your funding status, cash reserves, and growth potential.
• Investor-backed lines: If you've raised venture capital, some lenders will extend credit based on your funding rather than operational history.
• Founder-guaranteed lines: Using your personal credit to secure initial funding until your business establishes its own creditworthiness.
• Revenue-based financing: For startups with recurring revenue models, some lenders will extend credit based on your MRR/ARR rather than overall business history.

In this competitive financial landscape, startups should explore multiple options beyond traditional banks to find the best fit for their specific situation and growth stage.

How to choose the right credit line

After completing the application process, selecting the right startup credit line depends on your business needs and financial situation. Here are some factors that you should take note of:

1. Credit limit

Choosing a credit limit that aligns with your business needs is essential. A higher limit provides financial flexibility but may come with stricter qualification requirements or higher costs. Borrowing more than what you need can result in unnecessary debt, while a limit that’s too low may not fully support your new business.

2. Interest rates

Interest rates vary depending on whether the credit line is secured or unsecured. 

Secured lines of credit, backed by collateral like inventory or property, typically offer lower interest rates. Unsecured lines of credit, which do not require a personal guarantee, often have higher rates but are easier to access.

3. Repayment terms

Lenders offer different repayment structures. Some require monthly interest payments, with the entire amount due at the end of the term. Others provide revolving credit, allowing businesses to borrow, repay, and re-borrow as needed. Understanding these terms helps you choose a credit line that aligns with your cash flow.

4. Fees and costs

Besides interest rates, businesses should consider additional costs such as annual fees, withdrawal fees, and late payment penalties. These can significantly increase the overall borrowing cost. 

Comparing multiple lenders helps identify the most cost-effective option as well.

5. Funding speed

Traditional banks often take weeks to approve applications, making them a better fit for businesses that plan their funding needs. Online lenders, however, can process applications within days, making them ideal for businesses requiring quick access to credit line amounts.

Key takeaways

• A credit score of 670+, one year in business, and a steady revenue stream improve your chances of approval.
• Secured credit lines have lower interest rates but require collateral, while unsecured ones are more flexible but have higher costs.
• Compare interest rates, repayment terms, fees, and funding speed before choosing a lender.
• Online lenders offer faster funding to your business bank account, but banks may provide better terms for established businesses.

Conclusion: Financing options for your startup's growth journey

A business line of credit offers the financial stability and flexibility that early-stage startups desperately need. It helps cover operating expenses, manage cash flow gaps, and seize new opportunities without the burden of rigid monthly payments that can strain your developing business.

As a traditional business loan alternative, credit lines let businesses borrow only what they need, minimizing interest costs and financial strain. However, many startups face a common obstacle: qualifying for these credit lines without an established business history or consistent revenue patterns.

While business lines of credit are valuable tools, they're not the only solution for managing your startup's cash flow needs. Alternative financing options like Rho's corporate credit cards can provide similar flexibility with fewer qualification barriers for early-stage companies. Our alternative underwriting model looks beyond traditional metrics like business credit history, making it possible for promising young companies to access the spending power they need to grow.

Unlike conventional financing that may be out of reach for new businesses, Rho's approach removes unnecessary barriers, allowing you to focus on growth rather than financial limitations.

The right financing mix can provide your startup with the flexibility you need to efficiently manage cash flow, cover expenses, and seize new opportunities—even if you're just getting started.

Explore Rho's corporate card solutions today!

Pia Mikhael is a guest contributor. The views expressed are theirs and do not necessarily reflect the views of Rho.