“Blank Check” Commercial Line of Credit…Is it Right for You?
Contributed By Stephen Friedman, Sr. Vice President, Regents Bank
An open line of credit. Borrow how much you want when you want to. No covenants, no borrowing base, no “clean up” provisions. The only restrictions are the amount of the line, the maturity (usually one year), and the requirement to make your monthly interest payments of interest only. Sounds great, right? What’s not to like? A credit line like this is fine as long as you understand the unwritten and often unspoken rules about how your bank expects you to actually use it. Using a line of credit in the wrong way and for the wrong reasons can lead to the credit facility being frozen, termed out or called, leading to an immediate liquidity crisis for your business.
So what are the unwritten rules?
- Rule #1: Since the line of credit is a short term credit facility, do not use it for long term purposes like buying a long term asset.
- Rule #2: Make sure the line revolves – balances should go up and down along with your cash flow over the course of the year, ideally “cleaning up” or “resting” to a $0 balance for 30 consecutive days.
- Rule #3: Keep borrowings under a line of credit to no more than 75% of “eligible” accounts receivable. “Eligible” varies bank by bank but generally excludes: past due accounts, related party accounts, foreign accounts, and account balances to one customer that exceed over 25% of your overall accounts receivable.
- Rule #4: Keep line borrowings for purchases of inventory to a minimum.
- Rule #5: Don’t use your line or credit to fund operating losses.
Continuous access to credit is often the most important financing criteria for businesses, yet most business owners tend to focus on rate and terms when making their credit decisions, with the lowest rate and the most lenient terms winning the day. As in the case of the “Blank Check” line of credit, its lax terms could be your business’s unraveling if the unwritten rules aren’t followed. An experienced banker should know the unwritten rules and make sure that you know and understand them as well.
For More Information Contact:
Senior Vice President
1921 Palomar Oaks Way, Suite 100
760-431-7133 office, ext. 1408