Businesses have many needs for capital. They may need cash flow to cover accounts receivable, they may need funds to expand, or they may need money for payroll. Often, a business cannot or is unwilling to put up collateral to secure a line of credit. In this case, the company can apply for an unsecured line of credit.
When approving a customer for an unsecured line of credit, it’s important to have a good understanding of the company’s profile. The best way to do this is by using a complete and comprehensive credit application. A credit application should include:
- The name and address of the company
- The names and addresses of anyone who owns more than 20% of the business
- The annual gross revenue of the company
- An explanation of what the funds are for
Several documents help to underwrite the line request. Common documents requested are authorization to release credit, personal financial statements, the most recent two years of tax returns, and copies of legal documents such as corporate and LLC filings.
Five Cs of Credit
Lenders use an industry standard called the five Cs of credit to determine if the borrowers qualify for the line of credit.
Character: The company’s record of repaying debt. Usually found in a credit report.
Capacity: The company’s capacity to pay back the loan along with other expenses.
Collateral: Any asset that the company is willing to pledge to secure the loan.
Capital: The amount of money the company has on hand to pay debts.
Conditions: Any stipulations of the loan or line of credit. These include interest rate, term, and payment schedule. Conditions can include the state of the economy and other factors as well.
When underwriting an unsecured line of credit, most lenders request that anyone with 20% or more ownership in the company sign a personal guarantee. A personal guarantee is common in business lending so that the lender can recapture losses if the borrower defaults on the line of credit.
It is an innovative idea to file a UCC filing on the business to which you are lending. A UCC filing is a note that a lender adds to a business credit report to let other lenders know that the company has pledged to repay a line of credit. It can also establish liens on any collateral the business has pledged.
Unsecured lines of credit are especially useful for a business. Think of it as a credit card — you borrow money when needed and pay it back as soon as possible. Interest rates on unsecured lines of credit are higher than on secured credit because no collateral is pledged.