Business owners are often surprised and shocked when their line of credit is either terminated during the year or not renewed at the anniversary date. But there are a number of ways to stay in your bank’s good graces and avoid having to scramble to replace a line of credit.
There are many types of lines of credit to help you run your business. Owners must know what type of credit line they have, what terms and conditions the business must abide by, and when the line is due to be renewed, or they could find their credit line unexpectedly pulled.
Banks offer secured and unsecured lines of credit. A secured line of credit means the bank has taken a security interest in the business property or real estate. Unsecured lines of credit are often made based solely on the principal’s personal credit score and promise to repay, and the lender does not require any security interest in business property. Unsecured credit lines typically are a maximum of about $100,000.
In both types of credit lines, a bank usually makes a commitment for one year. At the end of the year, your banker will typically ask for updated tax returns and current financial statements and will do a credit check. If everything looks good and the line of credit has performed to the bank’s satisfaction, it is usually renewed for another year. But if something happens to the business during the year that dissuades the bank from renewing the credit line, the bank will expect you to pay in full or find another lender to take over the loan relationship. Business owners should know that nearly all lines of credit have a provision allowing the issuing bank to “call” the note due immediately without any reason.
By following these guidelines, most bankers and business owners will be able to work through nearly any situation that may arise:
- Understand what your bank expects: If your loan agreement has covenants, make sure you understand and follow them. They typically require you to submit copies of personal and company tax returns annually and interim financial statements quarterly. Getting the required documents to your banker on time will go a long way toward preserving a good relationship. If your business hits a bump in the road, go in person to your banker. Take current financial statements and explain what happened and what management is doing to take care of it.
- Give the bad news yourself: When something more serious than a bump in the road affects your business, make sure your banker hears about it directly from you as soon as practical. Bankers usually aren’t afraid of bad news, but no news scares them to death.
- Rest your line of credit: “Resting” a line of credit means paying the balance down to zero for at least a short period of time. Know in advance what your banker expects of your line of credit. Some bankers won’t care at all, while others may want to see it rest several times during the year.
- Communicate regularly: Contact your banker throughout the year. This helps keep surprises to a minimum.
- Don’t panic: If your line is not renewed and you can’t pay it off in full, there are options. Bankers have to work with their customers all the time when this situation arises. While you are looking for a replacement line of credit, ask your existing bank if it might agree to take some of the balance outstanding and convert it into a term loan. This happens every day in banks and often benefits everyone. If your banker is not easy to work with, consider turning to a factoring company (a commercial finance company that lends money against accounts receivable) or an asset-based lender (a commercial finance company that lends money for accounts receivable and inventory).
Sam Thacker is a partner in Austin, Texas-based Business Finance Solutions.