The Right Financing Solution for Small Businesses
January 18, 2024
Credit unions are currently in a favorable position to provide accessible, affordable, and flexible financing solutions to business owners, depending on their needs.
When business owners look for successful financial products for their growing company, a small business term loan is usually the answer, but sometimes, a line of credit could be a better fit.
Whether business owners seek additional funding for short or long-term funding, they will need your help to determine the right funding solution for them.
Lines of Credit: Advantages
Business lines of credit (LOC) provide important, valuable advantages, which make them a popular and attractive choice for business owners compared to term loans.
A line of credit creates a financial safety net for business owners by providing a short-term funding option to counter unexpected expenses, payroll, taxes, revenue shortfalls during seasonal downturns, or investment opportunities.
Having access to a pool of funds to withdraw from at-will eliminates business owners from having to pause operations or shut their businesses down for good.
1. Use What You Need, When You Need It
With a term loan, business owners have to guess the amount of working capital they believe they need. If the loan is too low, they have to scramble to find extra capital. If the loan is too high, then they are paying interest on money they didn’t need to borrow, which makes the investment unnecessarily expensive.
With lines of credit, a maximum credit limit is set so that the borrower can access capital on an as-needed basis and only pay fees on the total amount that is borrowed.
2. Increased Accessibility and Flexibility
If a business owner is denied a term loan due to their limited time in business, credit rating, or annual income, they may still have the ability to access a line of credit, typically due to less stringent borrowing requirements.
Typically, term loans are approved for a borrower’s specific need, such as a purchase of property, additional equipment, or expansion opportunity. With lines of credit, they offer increased flexibility, as they can be used for any purpose deemed necessary by the borrower.
3. Quick Investment Opportunities
Term loans provide a one-time use of working capital for a specific use. To access any additional funds, the business owner must apply for additional funds, which can be time-consuming and cause missed opportunities for growth.
With a line of credit, business owners can access a continuous source of capital by repeatedly borrowing and repaying the amount. This creates a strong source of cash flow, enabling business owners to seize investment opportunities instantly.
Lines of Credit: Challenges
Though lines of credit have their strengths, they also come with a few weaknesses and risks that credit unions will need to assist their borrowers in the decision-making process.
1. Lower Credit Limit
Lines of credit typically have a limit that is lower than a term loan. If the borrower has a limit lower than their working capital needs, then it will not be the most advantageous solution for the business owner.
2. High Fees
Compared to term loans, lines of credit generally have higher interest rates that increase the cost of the total amount borrowed. In addition to higher interest rates, some lines of credit carry processing fees, maintenance fees, and late payment penalties that can make the investment less efficient or affordable.
Furthermore, if the LOC has a variable interest rate, it can create:
- Unpredictable repayment amounts, making it difficult for the borrower to plan their monthly expenses
- A lack of understanding of how much borrowing will cost them in the long term
- The potential to spend more than they can afford if interest rates continuously increase
Guiding Business Owners Forward
Lines of credit and term loans are not one-size-fits-all solutions and each have their strengths and weaknesses. The right choice depends on each individual business situation, and your credit union can help business owners determine the correct funding solution to help them with unprecedented growth.
Don’t let financial confusion hold back business owners from receiving valuable funding solutions from your credit union.
Connect with NewtekOne to learn more.
Businesses expect more and NewtekOne (NASDAQ: NEWT) delivers core solutions that help businesses grow. As a partner, NewtekOne provides SBA lending services, business financing, merchant processing, payroll, insurance and website/technology services that credit unions can offer to members.