Business Lines of Credit & HELOCs

Brian Weckman – Chief Financial Officer & Partner, Electric Ease

Having advised many business owners over the past two decades, I’ve found that many of them don’t have an in-depth understanding of exactly how credit lines work and what to watch out for when utilizing them inside their business.

Lines of credit, and more specifically, credit cards, bank lines and home equity loans, are the most common type of financing used by startup businesses.  They are some of the easiest ways to borrow money and many people use them regularly to get their business off the ground and also to keep things going when their cash flow gets bumpy.

The biggest mistake I see business owners make regarding these types of arrangements is that they assume that they will always be available.  We tend to take things for granted while things are going smoothly and forget to keep in mind that it may not always be that way.  You must remember that a bank can shrink or close or credit lines at any time, if they foresee a negative credit environment shaping up.  At the onset of the financial crisis of 2008, we saw many business owners affected by banks lowering the credit limits of the lines, raising the interest rate and even shutting off any access to the unborrowed credit that was presumed to be available to the business owner.  I also witnessed a bank raising the minimum monthly payment on a $20,000 business line of credit from $300/month to $2,100/month.  That was one huge hit to the business’ cash flow right at a time that it didn’t need that kind of news dropped into its lap.

So, what can you do to protect yourself from these types of shocks?

  1. Try to avoid using the full amount of any of your credit lines, whether that’s a home equity line of credit (HELOC), credit card or business line of credit.  If things take a downturn, banks will always be more lenient to a creditor who hasn’t maxed themselves out.  It shows them that you’re not desperate.
  2. Talk to your bankers at the first sign of bumpiness in your finances.  This does not mean that you need to tell them all the bad stuff that you’re worried about.  But it does mean that you should get ahead of any potential negatives that they might get wind of on their own.
  3. Always try to get your credit line repayment periods locked in for as long as is prudent.  As long as the interest rate is reasonable, it’s best to have the loan maturity be pushed out as far as possible.  It’s almost impossible (barring a bankruptcy, divorce or business sale) for a lender to close or change your loan terms if everything is locked in and put in writing at the time you took out the loan.
  4. Strangely enough, if things get truly rocky for you, it’s usually a good idea to borrow out all the possible credit you can right away.  It may be expensive, but this can give you a lot of breathing room to take care of your business issues.  While the bank could potentially raise your minimum payments, they’ll have a hard time changing very many of the loan terms after you’ve borrowed the money.
  5. Lastly, if things get extremely desperate, move your checking and savings balances away from the banks that you have your loans with.  Most people don’t realize that in most loan agreements there are clauses that allow the bank to garnish or freeze your cash accounts at their institution if you stop making the payments, or if they believe you are about to default.  This rarely comes up, but it can be a game-changer if you wake up one morning to find that your cash isn’t available to you like you thought it was.

As always, be prudent in your borrowing and try to match it with your reasonable growth (and especially real cash flow) expectations.  Remember the old Bob Hope saying:

“A bank is a place that will lend you money if you can prove that you don’t need it.”