Credit facility: should you use one?

Credit facility legal provisions

If you do take out a credit facility, it will come with legal provisions. These cover the legalities and penalties of what will happen if you don’t meet certain conditions of your lending agreement. Such as, if you default on a payment.

What is a revolving credit facility?

The main difference between a revolving and non-revolving credit facility is that with the latter, once you’ve paid off your borrowed funds, that credit is no longer available to you.

What are the differences between a credit facility and a loan?

How you receive the money

With a business loan, you’ll receive access to all the funds upfront once it’s been approved. There are exceptions to this, like a development loan. This type of loan is designed to help fund a residential development project. The first part of the loan is used to buy the land, then the second part is drawn down in stages to pay for the build.

With a credit facility, you can draw down the precise amount of money you need to borrow at any time during the term. Providing you don’t exceed your credit limit.

How you pay the interest

With a loan, you pay interest on the total amount of money you’ve borrowed. With a credit facility, you only pay interest on the exact amount of money you use.

For example, you have a credit facility with a limit of £10,000. You don’t use it for several months, but then suddenly a customer fails to pay an invoice and you’re £4,000 down on your normal income. To pay for new stock, you can withdraw £4,000. Then, once you finally receive your customer’s payment, you return the money but only pay interest on the £4,000 – not the full £10,000 credit limit you have.

Access to capital

With a loan, it’s considered closed once all the monthly instalments are paid back. There’s normally no option to access more funds unless you apply for a new loan.

A credit facility can be renewed on an annual basis, giving you continued access to money when you need it (within your credit limit).

How you intend to use the funds

There are advantages and disadvantages of loans and credit facilities. It just depends on what you need the money for as to which is the most suitable option for you.

In general, a loan might be more suitable if you have a one–off large purchase or requirement that’s known about in advance. A credit facility is designed for more occasional support when unforeseen expenses land.

Credit facility fees to be aware of

With iwoca's Flexi–Loan, it's free to apply, you can get a decision in minutes and there are absolutely no hidden fees whatsoever. Other credit facilities may come with a number of fees on top of the initial interest rate. Below are some of the fees you might be charged if you take out a credit facility.

Commitment fees – This is a percentage, usually 2% or less of your credit limit. It’s there to compensate the lender for providing access to a potential loan, as they’ve set aside funds, but they can’t actually charge interest until you borrow money from it.

Annual renewal fees – This is only applied if you renew the credit facility, which tends to happen on an annual basis.

Availability fees – This is a percentage of the money that you didn’t borrow. It’s charged at the time when you pay the interest on the credit you did use.

Over limit fee – If you go above your credit limit, the lender could charge you a penalty for doing so.

Advantages of a credit facility

Flexibility

A credit facility offers you a great deal of flexibility to help you solve any short-term cash flow problems. An example of how credit facilities can be effectively used is in the ‘seasonal’ sector, where companies like ski resorts can use them to keep going over during the warmer summer months.

They are also flexible because you can use the money on whatever you like, from paying wages to buying materials. With other loans, you may have to specify exactly what you’re using the money for.

No assets required as security

Some loans are secured, although you can also get unsecured business loans. With a credit facility, you don’t need to put down any business assets as security (such as a commercial property).

However, many credit facility lenders will require a personal guarantee. This means you’re personally and legally liable for repaying the money you borrow.

Speedy decisions

Due to integration with online accounting software and automated credit decisions, you can set up a credit facility very quickly. Usually within a couple of hours. Sometimes instantly.

Access to the funds can even happen on the same day that you apply, depending on the lender.

New agreements aren’t needed

Unlike with a loan, you don’t have to set up a new agreement every time you use a credit facility. You can just renew it (sometimes for a fee) at the end of the term, providing your lender is happy to do so.

Online portals for ease of use

Many credit facilities come with online dashboards, which makes them simpler to manage.

Only pay interest on the money you use

You might have a credit limit of £10,000, but you only ever pay interest on the amount you actually borrow. When you don’t have an outstanding balance, you don’t pay any interest. With a traditional loan, you pay interest on the total amount you borrowed, regardless of whether or not you used it all.

No long-term commitment

You might only draw down on the funds once – and never use the facility again. Although you may still be charged fees for having the facility available to your business.

Can help to keep your supply chain happy

Having reliable suppliers helps you to fulfil your customers’ requirements, which inevitably helps your business to grow. With a reserve of capital to hand, you can pay your suppliers on time, or even upfront, if you have a particularly large or urgent order.

A credit facility can grow with your business

If your credit facility is well managed and your business is growing successfully, your lender is more likely to renew it and even extend your limit so you can draw down more money when you need it.

Disadvantages of a credit facility

High interest rate charges

Compared to a business loan, the interest rate charges are normally higher. This is because credit facilities are predominantly designed for short-term, occasional use.

The amount of fees

It’s not only the high interest rates that can be costly. Credit facilities normally come with a number of fees that you have to pay on top of the interest charges.

Only a short-term option

Credit facilities typically run for a short period of time, from six months to two years. So if you’re looking for long-term funding, a credit facility is unlikely to be the best option for you.

Changing terms

With a credit facility, the terms of use and interest rates could change at any time, often with very little notice. If the new terms aren’t desirable, you don’t have to accept them, but you do if you want to continue using the service.

Alternatives to a credit facility

While a credit facility can be a flexible way for a business to manage cash flow, it’s very much a short-term solution and might not be the best way to cover regular or fixed expenses.

Fortunately, there are lots of other forms of finance you could consider that might be more suitable to your needs, or that you can use alongside a credit facility. Below are just a couple of these options.

Trade credit

This is an agreement between a buyer and supplier to extend the payment term of stock ordered (usually between 30 and 60 days). This payment term is decided by the supplier.

This can be a great way to purchase stock as it’s typically interest free. Some suppliers even offer buyers discounts (typically 1–3%) for repaying early – so you could even end up saving money by using trade credit to buy stock.

Not every company will be entitled to trade credit, but if you have a good history of repayment, you are more likely to be accepted. Discover more about trade credit.

Recovery loan

If you’re looking for a more long-term form of finance or need funds to make a large, one-off purchase, a business loan could be just what you need.

If your business has been affected by the coronavirus you might want to have a look to see if you're eligible for our recovery loan (RLS).

Business crowdfunding

Thanks to the internet, the popularity of business crowdfunding has gone through the roof over the last decade. It enables you to connect with millions of people who could be willing to financially contribute to your business. Whether you’re a start-up or well-established company.

Using an online platform, of which there are many, you’re able to raise awareness of your venture to potential individuals, investors and groups. You can then raise capital using one of the four main types of crowdfunding:

1. Equity crowdfunding – you offer a stake in your business.

2. Reward crowdfunding – you offer perks.

3. Donation crowdfunding – you don’t offer anything tangible, it’s a chance for people to contribute money to a cause they believe in.

4. Debt crowdfunding – similar to peer to peer lending in that you pay the investor interest on their investment, and the crowdfunding platform is used as a way to draw attention to your venture.

The FinTech company Monzo is an example of how effective crowdfunding can be (although this is definitely an unusual case). They raised £1m in 96 seconds back in 2016. They attracted that so much interest, their crowdfunding platform ‘Crowdcube’ crashed.

Discover more about crowdfunding, including the advantages and disadvantages of using it.

Trade finance

This might sound similar to ‘trade credit’, but it works in a different way. Trade finance is designed to help make international trade easier and is used to bridge the finance gap between exporters and importers.

A financial institution, like a bank or export credit agency, acts a third party between the exporter and importer to reduce the risks associated with oversees trade. For example, they can provide a letter of credit. With this, an importer’s bank makes a promise to the exporter they’ll receive payment as soon as the transaction is complete.

Discover more about trade finance.

More alternatives to a credit facility

This guide to credit facilities, and the above business finance options, will hopefully give you a clearer idea of what is the right solution for your funding needs. But if not, there are plenty of other forms of finance you could still consider.

• Peer to peer lending
• Start-up funding
• Invoice financing
• Merchant cash advance
• Commercial mortgages
• Business overdraft
• Auction finance
• Asset finance