With the year 2020 underway, you’re likely planning new initiatives or setting revised goals for firm growth. To do so, you’ll need adequate financial resources.
You may be thinking about obtaining outside financing for your firm, but what’s the first step?
First, determine what type of financing will be most effective in meeting your needs by starting at the beginning —identify the differences between taking out a loan and securing a line of credit before researching less traditional options.
How it’s funded
The number one difference between a loan and a line of credit is how it’s funded.
If you’re looking for the full amount of funding at one time, a loan might be your first choice. When you want to make a large purchase, such as hire a marketing agency, or consolidate other debt, a loan may afford you the ability to do so.
If you’re looking to draw varying amounts of money periodically, for instance, to fund case expenses or for operations, a credit line may be a better option for you and your firm. You’ll be approved for a maximum threshold amount but are not required to withdraw all of it at once. If the timing of your fees fluctuate (as most contingency fees do) or you find your income and expenses tend not to coincide, a line of credit can provide you liquidity and a steady source of working capital.
Another difference between a loan and line of credit is how interest is calculated.
When you receive the proceeds from a loan, interest immediately begins to accrue. Additionally, the interest rate you are charged is likely to be a fixed percentage and may be lower than you’d receive with some other financing options.
With a line of credit, you only incur interest on the amount that you actually utilize, not the total available sum available to you. As such, if you have been approved for a $2 million line, but you only borrow $500,000 to start, you will only be responsible for interest payment on the $500,000.
Be sure to ask potential lenders what the rate will be, as it may be higher than on a traditional loan, and if it will vary throughout the life of the financing. Also check to see if the lender charges any additional fees on each withdrawal.
The terms of repayment are different between loans and credit lines.
A loan generally contains terms for specific repayment amounts, paid in installments over a finite period of time. In addition, loans will mature on a specific date—periodic payments are calculated to reflect the interest accrued and principal amount to be repaid within that time frame.
In contrast, repayment of funds from a line of credit is based only on what is actually borrowed. Unlike a loan, you can choose to pay down the line soon after drawing from it, thereby restoring your borrowing capacity, or you may pay that amount in increments more like you would in a traditional loan format.
Before employing any sort of funding, it’s imperative to ensure your credit score is in a good place, map out exactly how you’ll use the financing proceeds and have a plan in place to do so.
Traditional lending institutions, like your current bank, are always a good place to start when researching what’s available to you and your firm. That said, contingent-fee practice comes with a unique set of challenges. Specialty lenders exist that may be better suited to meet your needs and provide more significant financing that is customized to your firm’s individual situation. Specialty lenders who have skilled attorneys on staff may also be more understanding – and thus more flexible – in structuring the loan or credit line.