WHITE PAPER HOW TO GET A LINE OF CREDIT THAT S RIGHT FOR YOUR BUSINESS

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1 WHITE PAPER HOW TO GET A LINE OF CREDIT THAT S RIGHT FOR YOUR BUSINESS

2 Introduction Obtaining a line of credit represents an important step for startup and emerging companies, providing access to working capital to finance daily operations and grow the business. But there s more to it than just walking into a bank and asking, How much can I borrow? This white paper addresses four areas that small business owners need to know to make informed decisions about obtaining a credit line for their companies: the proper use of credit lines, the qualification process, how to find the right bank, and whether or not to get a company credit card. White paper written by Russ Wertz Founder and CEO of Wertz & Company, LLP Table Of Contents What is a Line of Credit? 3 How Do You Qualify for One? 4 Choosing A Bank That s Right For Your Business 5 Do You Need a Company Credit Card? 6 2

3 What is a Line of Credit? When clients ask us if they can get a loan for their business, we always respond with the truism that you should never ask a bank for money when you really need it; always have it lined up in advance. Their second question normally consists of, What type of loan should I get? Banks normally grant two types of standard loans to small businesses: installment loans and lines of credit. Installment loans are used to purchase equipment, computers, office furniture and similar types of assets. The business borrows a specific amount of money for a defined period of time, usually three to five years. The loans come with a predetermined interest rate that usually does not fluctuate (i.e. a fixed rate loan). The borrower pays monthly installments that include both principal and interest amounts. At the end of the loan period, the purchased asset is usually owned free and clear. A business line of credit is not designed for purchasing these types of items. Instead, a line of credit allows a business to finance short-term and/or seasonal cash flow needs, such as the payment of vendors, the funding of a pension plan, or the payment of taxes. Lines of credit allow businesses to function on a routine basis so they won t be hindered by mail delays, unexpected collection issues, claiming of early payment discounts from vendors, and other specific cash needs. Banks normally structure lines of credit with the requirement that the borrower owe a zero balance for at least one 30-day period per year. This requirement, along with others, is called a debt covenant. If it is not met, the bank can call the line of credit, and any outstanding funds become immediately due and payable. Lines of credit are usually granted annually, and typically have floating interest rates. Most require the company and its owners to guarantee the repayment of any borrowed amounts upon the expiration of the line s time period unless the bank is willing to renew. Lines of credit allow businesses to function on a routine basis so they won t be hindered by mail delays, unexpected collection issues, claiming of early payment discounts from vendors, and other specific cash needs. 3

4 How Do You Qualify for One? Now that you understand the purpose of a business line of credit, the question becomes, How do I qualify for one? When banks loan money, they look for two types of repayment paths. The first is based on the profitability of your business, and requires proving to the bank that your business generates enough cash flow to repay any advances you take from the line of credit. This is usually done by providing the bank with your business plan, tax returns, financial statements, and a personal statement of net worth. In addition, most banks will want a one-page executive summary stating why you need the line, how much you need, and how you plan on using the funds. The second source of repayment that a bank will require is some type of security interest in a hard asset they can quickly foreclose on should you not meet the repayment terms required by the line of credit debt covenants. The most common types of collateral are a trust deed on real estate that you own, or having another individual with substantial assets such as a family member co-guarantee the loan. The interest rate, as well as the bank fees charged annually to originate and maintain the line of credit, will vary depending on several factors. These include the institution, the quality of the credit request in terms of your financial resources, and the overall relationship you have with the bank. These annual fees usually approximate 1% of the available credit that is granted. 4

5 Choosing A Bank That s Right For Your Business Initially, most entrepreneurs turn to the bank where they maintain their personal accounts to obtain a line of credit. However, this could be a mistake. Banks usually classify themselves as either a retail bank or a business bank. Retail banks cater to the general public, and specialize in providing all manner of bank accounts, credit cards, home equity loans, safe deposit boxes, and general individual banking services. In contrast, business banks look to attract businesses of a certain type or size as their primary customer. They do this to meet their banking needs, which contain some retail banking products but also tend to emphasize the installment loans, lines of credit, commercial real estate loans, and other business banking products. Business banks can and do handle the banking needs of individuals, but these individuals tend to be connected to a business that the bank has as a client. Banks can vary widely in terms of target market, specialty niches, size and type of clients, approach to customer service, and geographic locations. To find the best fit for you, take a close look at your company, its needs and its values. Then research the banks in your area to see what they offer. The best approach to this type of research involves a combination of Internet searches and referrals from satisfied customers in similar businesses, including your competition. Endorsements from professional advisors (such as your CPA firm), who know the banks within your geographic area, are also advisable. Generally speaking, larger banks tend to offer less personalized service that is not relationship-based. They also tend to have constant personnel turnover. Smaller community banks tend to focus more on the relationship and service aspects, but can be more expensive. Regardless of where you decide to bank, plan on having all of your business needs line of credit, installment loans, and checking accounts at one bank. In most cases, the bank will require it. Business banks can and do handle the banking needs of individuals, but these individuals tend to be connected to a business that the bank has as a client. 5

6 Do You Need a Company Credit Card? Another issue for many new and emerging business owners is whether or not to get a company credit card. Your company is up and running, and you have enough revenue coming in to pay some of the bills that have been piling up. You followed your attorney s advice and created an S-Corporation to protect yourself from personal liability. You ve filed your first corporate tax return, and while the bottom line wasn t great, it looks like the business is going to survive. Now that you ve made it through the startup stage, you want to get further organized. You re starting to travel for business. You re taking a few clients out for lunch. You need to order some office supplies through the Internet. No problem just put it on a credit card, right? The question is, do you need a corporate credit card to charge these items and deduct them for tax purposes, or can you use a personal credit card? There is no requirement that a corporation, or an LLC, must have a credit card issued in its name in order to deduct business expenses for tax purposes. So using a personal credit card is okay. Plus, they re usually easier to obtain, given that your personal credit history is probably much more extensive than your newly formed corporation s. That being said, here are a couple of quick rules to consider in the credit card debate: If you decide to stick with personal, pick one of your personal credit cards and use it only for business. If you have more than one business, use a separate card for each business. Do not charge personal or non-business items on this card. Make sure it has enough of a credit limit to allow you to charge the needed items. For tax purposes, keep the monthly statement as your detailed record of the expenses incurred. Have your accountant analyze the monthly statement and categorize the charges into various expense categories. As long as you can document the business purpose for the charges incurred (including names of people taken to lunch or other entertainment), you do not need to keep signed receipts. Always pay the credit card bill from the company checking account. Starting and running a business is hard work, especially during the early growth stage. Once the business has been running for a number of years, you can apply for and obtain a company credit card. In the interim, save yourself some time and effort and utilize a personal credit card. 6

7 WHY WERTZ & COMPANY? Throughout the history of Wertz & Company, we have always put clients first. And although the business tools we use and business climate we operate in has changed, our approach to service is exactly the same as the day we began. Our business is built upon a keen understanding of the needs of our entrepreneurial and small business clients. We surround their most vital needs with strong suite of advice, ideas, competencies and solutions to help them thrive. We embrace entrepreneurs for their independent, free-thinking, visionary spirit, and specialize in serving their unique needs. One of the most important messages we emphasize is the importance of working on their business, not just in it. This requires honest assessment and strategic planning. FOR MORE INFORMATION Call Visit