Business Loan vs Line of Credit
In every Irish city, town and village, SMEs provide the essential goods and services that ensure communities survive and thrive. More often than not, this requires working far beyond the 9-to-5. And it means constantly worrying about where orders and customers will come from, next week and into the future.
GRID Finance is a business finance provider with a difference. We understand and applaud the critical contribution that SMEs make to Ireland, and design our products accordingly. This means taking a far more imaginative approach to lending, one that recognises the realities of business life. Unfortunately, not every financial institution is this flexible. As a result, far too many SMEs face unnecessary pressure when borrowing.
In this article, we explain why this needn’t be the case if you are considering whether to borrow using a Business Loan or Line of Credit as a viable alternative to a traditional bank loan.
Understanding Your Business Loan Options
As with any commercial subject, the more you know about the type of loan you’re choosing, the better the decisions you can make. So it’s worth taking a moment to consider the function of each business loan type and when applying for one might be appropriate.
What is a Business Loan?
A business loan is money provided by a lender, such as a bank or financial institution, to a business for a wide number of purposes. These can include purchasing equipment, managing cash flow or providing general working capital.
Business loans are either secured (i.e. they are backed by collateral such as property or assets) or unsecured meaning no collateral is required. To protect themselves when offering unsecured Business Loans, lenders generally charge higher interest rates, meaning higher monthly repayments.
Importantly, Business Loan repayments are usually paid in regular instalments over a fixed period and at a set rate of interest.
Pros and cons of Business Loan
The advantages and disadvantages of a Business Loan should be carefully considered before anything is borrowed.
On the plus side, a Business Loan is a relatively flexible, straightforward and efficient way to fund things like equipment purchases or unexpected growth opportunities. As such, it can help drive quicker expansion because there’s no need to build up the necessary funds from company profits. At the same time, repaying a Business Loan can help enhance your credit history, (which helps secure future financing) and interest is often tax-deductible.
Less positively, unsecured Business Loans may come with elevated interest rates. At the same time, defaulting on a secured loan will endanger whatever collateral you have offered. Not keeping up with regular repayments could also harm your business’s credit rating and lead to legal problems.
Exploring lines of credit
Having considered Business Loans, let’s take a look at an alternative business financing option: Lines of Credit. There are specific occasions and purposes when these may be a more suitable and cost-effective choice of capital loan for your business.
What is a Line of Credit?
A Line of Credit (LOC) is a flexible loan that lets businesses borrow money up to a pre-agreed limit, whenever it’s needed. Unlike a traditional lump sum loan, a LOC lets borrowers withdraw any amount within the limit and only pay interest on that specific amount.
As such, a LOC could be seen as a financial cushion which can be used for unexpected expenses or to cover short-term projects. As with all non-bank loans, LOCs can either be secured or unsecured, and typically have variable interest rates.
Pros and cons of Lines of Credit
Primarily, the flexibility of LOCs makes them very attractive since they offer businesses easy and fast access to funds whenever it’s required. This can be very useful for managing cash flows and unexpected expenses.
Similarly, as a financial cushion, a LOC can help ensure operations continue uninterrupted during slow periods or seasonal downturns. Making repayments in full and on time means a LOC can help improve a business’s overall credit score and so make future borrowing less expensive.
However, LOCs also have a number of drawbacks. For example, their interest rates are usually higher than those of standard loans. Various fees can also raise the total cost of borrowing while some LOCs may also have short repayment periods. A requirement to repay quickly over shorter terms could end up putting pressure on a business’s cash flow.
Comparative analysis: Business Loan vs Line of Credit
Having examined the specifics of business loans and lines of credit, let’s look at how both stack up against each other. Obviously, each type of business loan will have advantages and disadvantages depending on your business’s current circumstances and ability to repay.
Key differences
The differences between a Business Loan and a Line of Credit essentially boils down to their structures and respective levels of flexibility.
Most elements of a Business Loan are fixed: its size, purpose (for example, to buy a specific item of equipment), interest rate, date of regular repayments and how much is repaid each time. Generally, larger amounts are borrowed via Business Loans compared to Lines of Credit.
In contrast, a Line of Credit is very flexible and allows borrowing up to an agreed limit. In this way, it’s similar to a credit card: typically, smaller amounts are borrowed to cover items such as expenses or cash flow management. Payments are then only required on what has been borrowed rather than the full amount available.
Scenarios where each option is suitable
So, which type of scenarios would lead a business to opt for either a Business Loan or a Line of Credit?
In general, the size of the loan will be the deciding factor.
Large expenses, such as purchasing machinery or paying a lump sum upfront so that operations can be expanded, are usually financed by a Business Loan. On the other hand, a Line of Credit could help tide a business over if, for example, it faced a cash flow dip at a time when it needed to restock inventory.
Another possibility could be if an attractive discount was being offered on a bulk purchase of stock. In this case, having access to a Line of Credit would allow the business to jump on a bargain there and then.
Financial considerations
More than anything, the most important consideration for any SME business owner thinking of borrowing is the loan’s financial impact. Financing should make it easier to grow or serve customers rather than impose a burden on the business. So in the following section, we look at some of the financial issues that should always be considered…
Interest rates and repayment terms
Business Loans and Lines of Credit are very different financial products. So it’s not surprising that their interest rates and repayment terms differ significantly.
Business Loan interest rates are fixed and can vary a lot, depending on the borrower’s credit score and other factors. However, set repayments on a fixed date each month offer the certainty of knowing exactly how much must be repaid and when. Usually repayment periods run from one to five years, but can extend up to 25 years for larger amounts.
The flexibility of Lines of Credit is reflected in their interest rates. These can fluctuate and depend on factors such as the prevailing interest rate when the money was drawn down, along with the borrower’s credit history.
How to choose what’s best for your business
It’s decision time – so how do you choose which financing option is right for your business? The answer is simple: you need to weigh up the specific needs of your business at the moment, and in the months and years to come.
Assessing your business needs
No business is quite like yours. It’s at a specific development stage and faces unique challenges and opportunities. So when deciding between a Line of Credit or a Business Loan, all your current circumstances must be taken into account.
If your business regularly faces short-term or unexpected expenses (purchasing seasonal inventory, or handling unexpected costs, for example), Lines of Credit offer real flexibility in drawing and repaying funds.
On the other hand, if you’re planning a large, once-off investment – such as acquiring equipment or purchasing premises – a Business Loan would be more appropriate. With a lump sum provided upfront and fixed repayment schedules, Business Loans are ideal for businesses with a clear, defined financial need and the ability to commit to long-term repayments.
So what are the key factors that will determine whether a Line of Credit or a Business Loan is your best option? In a nutshell, they are:
- the stability of your business’s cash flow
- your reason for borrowing and;
- your confidence that you can make repayments without facing undue financial stress.
When to choose GRID Finance products
Let’s say you’ve decided that, based on the criteria listed above, it would be appropriate to apply for a Business Loan. You may decide that you can comfortably afford a fixed repayment every month. But what if you’re not so sure which type of business loans are best for your company?
In this case, a Flexible Repayment Loan from GRID Finance offers up to €500,000 without fixed repayments. Instead, payments are varied according to business turnover which makes them more manageable. By basing your repayments on a percentage of your weekly rolling sales average, they automatically reduce at quieter times and rise when turnover picks up.
Similarly, while a Line of Credit offers a cushion to handle unexpected expenses or cash-flow hiccups, a Short-Term Loan from GRID Finance is also a very business-friendly option. Again, as repayments rise and fall in step with your turnover, they won’t put the business under pressure when cash reserves are low.
Application process and documentation
Extra work is the last thing anyone running an SME needs. Knowing this, GRID Finance has streamlined the process of applying for a loan: if you have the necessary documents to hand, meet the eligibility requirements, and use a desktop computer, applying for a Grid Finance loan generally only takes around three minutes.
Preparing to apply
Before doing anything, you need to ensure your business is registered in the Republic of Ireland, has traded for nine months or more and takes some or all of its revenue by card machine, or online using a payments processor.
If all this checks out, set up a GRID account online to apply for a loan of between €10,000 and €500,000; if you need more, let us know and we’ll see what’s possible. Then upload the documentation listed below, complete some declarations and submit your application.
Documentation requirements
When applying for your loan, you need six months of up-to-date bank statements in soft copy format. Alternatively, a read-only Open Banking Connection is acceptable. In addition to either of these, a valid tax clearance certificate is also required on your loan application. This can be easily obtained from Revenue. Larger loans may require additional items such as audited financial accounts and management accounts.
After you apply for your chosen funding solution, approval can happen within 48 hours. Following this, funds should be transferred to you in another 24 hours approximately.
The GRID Verdict on Business Loans Vs Line of Credit Funding
At some point or other, virtually every business will find it needs to borrow. Whether overcoming short-term challenges, taking advantage of opportunities or investing for expansion, the right choices on the type of finance sought must be made to avoid imposing unnecessary financial pressures.
The business environment is always changing. For this reason, it’s far more preferable to use a borrowing option with genuine flexibility. Rather than locking borrowers into rigid repayment schedules, GRID Finance offers solutions that adapt to the ups and downs of business life.
So if you’re a business owner ready to borrow but not ready to put your business under undue pressure, remember that GRID Finance’s options are specifically designed to meet the ever-evolving needs of Ireland’s SMEs.
