When your business needs money to grow – or to keep the doors open – where do you get it? According to the Meredith Whitney Advisory Group, 82 percent of small business owners use credit cards as “a vital part” of their funding strategy. Not the best idea, notes Tom Gazaway, founder of small-business loan consulting firm Hawkeye Management in Blackwood, NJ.
“The problem is that most small business owners either use personal credit cards or the wrong type of business credit cards – the kind that are reported on their personal credit score,” he says. “The result is that their credit scores get worse, they don't get the best interest rates, and they miss out on tax benefits.”
Worse yet, the sky-high interest rates charged by credit-card companies suck cash from the till, creating a cash-flow problem that can lead to the business’s demise. In a 2009 study by the Ewing Marion Kauffman Foundation, which focuses on fostering entrepreneurship, it was found that every $1,000 racked onto a small business’s credit cards increased the business’s chance of going bust by 2.2 percent.
Given the downside, why do business owners turn to plastic to fund their companies? Primarily because it’s a form of unsecured credit that’s fairly easy to obtain. That’s been especially true since the economic downturn hit at the end of 2008 and traditional bank loans became harder to find. Shrinking real-estate values also meant fewer entrepreneurs could tap secured home-equity lines of credit.
“Nowadays [retirement fund] leveraging and credit cards are the most popular forms of start-up debt financing,” says Gazaway.
The advantages of unsecured business lines of credit (UBLOCs)
A better way to go, says Gazaway, is to seek an unsecured business line of credit from either a traditional or specialty lender. In some cases, vendors may offer a credit line to help keep your business purchasing goods from them.
The other, more common route is to obtain an unsecured credit line from a bank. A typical UBLOC might be for up to $100,000. Interest rates are much lower than credit-card companies charge, monthly payments are low, and as funds are paid back they can be borrowed back out again.
Is a UBLOC a good option for your small business? Here are a few factors to consider:
Business purpose. Why are you seeking this cash? UBLOCs are best used for short-term business goals where you expect the money to help the company bring in more revenue that will help you pay the balance back down. If you want funds to purchase a piece of equipment, for instance, you might want to get a secured equipment lease from a specialty equipment lender instead.
Credit score. Your personal credit rating will be key to landing a UBLOC – Gazaway says a Fair Isaac and Company (FICO) score over 700 is desirable. If your score is lacking, build it up by getting a business credit card for business-related expenses and making prompt, regular payments. Keeping your spending well below the credit limit offered by your card company will also help your score.
Track record. Most banks want to see you in business at least two years. They’ll also want to see several years of financial records to demonstrate your business has the cash flow and profit margins to service the loan.
Your industry. Some industries such as restaurants and real-estate firms are considered high-risk. It’ll be tough to get an unsecured loan.
Find the right bank. Not all banks issue unsecured lines, and those that do will keep them to a small portion of their total lending. Look for a business-focused bank that has a history of unsecured business lending.
As you can see, there are many hurdles to obtaining an unsecured business credit line. But the advantages of this form of credit make it worth the work, Gazaway says. It’s far better to get the cash your business needs without having to pledge your home or business assets in exchange.
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