How to Be Prepared to Offer Business Lines of Credit Advice
Accountants and bookkeepers are often the first to know about a cash flow problem that their business or nonprofit clients are having, ultimately leading to questions about getting a line of credit.
There is no question small business clients are hurting right now and you've been fielding questions about lifelines like the SBA's Payroll Protection Plan and the Emergency Injury Disaster Loan. But outside of government lifelines, which still have many questions tied to them, another alternative for your clients to get necessary capital is a business line of credit.
This article, by Financial Solutions Managing Partner Stephen Halasnick walks you through the process and how you can best advise your small business or nonprofit clients.
For your small business clients, a temporary lack of cash can often impact making payroll and numerous other issues. Many of these businesses and nonprofits are good companies that just happened to have a short-term cash crunch.
Now, there are more options than ever before to help set up a small business line of credit. This article will discuss signs that a business or nonprofit needs a business line of credit; real-life experiences when business owners deal with a bank; what will a bank look for to approve a small business credit line; what alternatives are there to a commercial or local bank; and the costs of a line of credit.
Signs That a Client Needs a Business Line of Credit
Accountants often know the signs if a business or nonprofit should be getting a line of credit. It often starts with an urgent call from the owner under duress.
Because many of you do the taxes at the end of the year, or month-end closes, you often know if the company is a good company that just has times of the year when there is a cash crunch. Profitable companies are the ones that should set up a line of credit because they will be able to pay it back.
However, companies that run in the red a lot should hardly ever set up a line of credit because the credit line can mask the problems with the company. As their financial advisor, business owners will often ask for your advice and direction.
Here are a few helpful hints to recognize if a line of credit is the right recommendation:
- Review the client's past financials and current YTD income/balance sheet
- Ask the client what has changed in the business
- Know how much debt the client has outstanding
- Ask the client where their company is headed
- Does your client know what their personal credit score is
- Ask your client how much personal collateral they have
Real-Life Experiences When Business Owners Deal With a Bank
Over the last 25 years, I have built seven companies and on two separate occasions, I got advice from my accountant and my financial advisor that a bank was going to definitely approve or increase my line of credit because my business was doing so well.
In both of those situations, we were all surprised when the banks I approached either turned me down or took so long to decide, that it no longer helped. It cost me many sleepless nights.
In the first situation, the banks said I didn't have enough collateral (business or personal) to back up the line of credit even though my company was generating excellent profits and I had a very nice AR to pledge. In the second example, my sales team had had a great month and I outstripped my line of credit.
When I approached the bank about an increase they said it would take them a month to decide. If I hadn't found another solution I would have missed payroll, which would have greatly caused a ton of turmoil in the staffing business I owned.
I never forgot those situations because of the problems it caused and ever since then I made sure that I always had a line of credit in place. It's also why I am an evangelist when it comes to advising business owners and nonprofit executive directors that the time to get a line of credit in place is when you don't need it.
What Will a Bank Look For to Approve a Small Business Credit Line
The rules that apply for a bank line of credit will be different based on the size of the business and also the current economy. However, in general, you can count on three things that a commercial or local bank will want for businesses or nonprofits with under $10 million in yearly revenue.
Banks are going to want personal or business collateral to back up the line of credit. If it is business collateral that is being pledged then the amount the bank will approve will depend on the type of collateral.
Personal collateral most often will be in the form of equity in a home. Considering that many business owners are cash poor and younger, there often isn't home equity to pledge.
If the business is under $10 million in yearly revenue then you can pretty much count on the bank wanting a personal guarantee. Keep in mind that if the equity in a home is being pledged as well then the spouse will also be required to sign. Sometimes that conversation can be a tricky one that many business owners don't want to have.
Banks often want a personal credit score of 680 or better. Business owners' credit scores are often lower because the owners have had to put a lot of his/her PG on the line for credit cards, leases, and other financings. A good site to point your clients to for a free credit report is Credit Karma if your client is unsure.
What Alternatives Are There to a Commercial or Local Bank
After the 2008 recession bank lines of credit completely dried up. What filled that gap were companies that started to service small businesses. Alternative lenders began to offer unsecured business lines of credit with no personal guarantees with approval turnaround times in days. And for the first time, a loan for nonprofits in the form of a nonprofit line of credit was being offered.
Some alternative lenders now charge no fees until the line is actually used making the line a better product verses a bank that will charge set up fees or points. The line of credit from an alternative lender has now become a cash backup plan that is much easier to get in place ahead of time.
Costs of a Line of Credit
One question you might be asking yourself is if a bank or an alternative line of credit is cheaper? The answer to that question is, it depends. If one plans on using their line of credit a lot, a bank will probably be less expensive.
If your client has collateral, a personal guarantee, credit over at least 680 and plenty of time, then a bank is the way to go. However, if your client falls short on any of these, then there are a lot of reputable alternative lenders that are providing lines of credit to small businesses and nonprofits that you can feel very comfortable recommending.