Not every startup company needs a big wad of investment cash in order to get started.

What many companies need is some basic operating capital to cover expenses until they can start generating some cash.  The weapon of choice in this instance is a Line of Credit (LOC).

What is a Line of Credit?

Think of a line of credit the same way you think of a credit card.  You are offered a credit limit of a certain amount (let's say $25,000) and you draw down on that limit as you need it.  At the end of the month you make payments on what you've drawn down on.  Pretty simple, right?

How do you get one?

Your local bank should be able to help you facilitate your line.  The Small Business Association (SBA.gov) even has a program that will help underwrite your loan up to about $25,000.  As a new business you may have to sign personally for the line for the time being, but with enough history and good management, you can eventually get the line setup without your guarantee.

What *NOT* to use it for

Before I tell you how to use a LOC, let me tell you how NOT to use it.

Don't use it to pay people.  Chances are if you can't make payroll, your line of credit isn't going to help you out much.  If you're just late getting a check in from a customer and you just need to buy yourself a few days, great.  But if you are literally paying people directly from the LOC without any backup income to support it, that's a bad idea.

It's a bad idea because it's very difficult to pay back the cost of people.  Compare that to spending the money on advertising, which creates a more direct cash return.  In that case you are really just buying yourself time to bring paying customers in the door.  Paying for people (unless they are salespeople) rarely translates directly into customer cash, so it's a no-no.

Don't use it to pay down debts.  The idea of using one form of debt to pay down another isn't a brilliant idea.  Unless you're paying 22% APR on your credit cards and your LOC interest rate is around 10%, all you're really doing is covering up the fact that you have outstanding debt you can't pay.

Don't use it to buy office equipment.  This may sound ridiculous - why would you take on extra capital if you weren't going to use it to buy a new laptop, desk and a cell phone?  That's because you don't want to create short-term debt like a LOC for things that won't create immediate financial returns to the business.

While it's tempting to use your new cash horde to buy shiny new office products, it's not a good use of cash.  Anything you can do to avoid buying office supplies should be considered.  If you can put a closet door on a pile of cinder blocks to make a desk you're better off than using your LOC to buy office equipment. 

You need to conserve your LOC for investments that are going to directly drive revenue in the door.

Good Uses of Your Line

The key to effectively using your LOC is to focus that spending on revenue-generating functions that you can activate right away. 

Spend it on marketing.  What I really mean here is "spend it on marketing that works".  You may not have tested any marketing efforts yet, in which case what we're talking about is testing your marketing to figure out what works, and then putting your LOC money to work.

For example, at Swapalease, we went from spending $3,000 per month on marketing to over $30,000 per month within our first year, simply by using our Line of Credit.  We would draw down enough cash to put into our online marketing efforts, which would then return in the form of sales within 30 - 60 days. 

We just needed some credit in the bank to tide us over until we could recoup our marketing investment.  That was a fantastic use of our LOC because we had a formula that worked - we just needed more cash to put into it.

Spend it on inventory.  Inventory is the most obvious use of your Line of Credit.  You simply need to have the fund available to purchase the inventory that you want to sell.  It's pretty much what the LOC was invented for.

However, make sure you keep enough in reserve on your LOC so that if you end up holding onto your inventory for too long, you can use some of the LOC to pay down the monthly payments.  Not the best strategy, but there if you need it.

Spend it on growth.  Really what we're talking about here is finding aspects of your business that are simply not growing because they are constrained by cash.  This could be your sales efforts, your product line offerings, or even a few more people to complete a paying project.  All good uses of your LOC.

Every business should have a Line of Credit whether they need to use it or not.  It's one of the best business tools that allows you to grow when you need to without giving up equity or paying back an unused loan.

It's better to have a Line of Credit and not need it, than to need a Line of Credit and not have it!