Use a line of credit for needs that turn back into cash within the business cycle, such as receivables, inventory and seasonal swings, and a term loan for things that pay back over years, such as equipment, an acquisition or a refinancing. A line revolves: you draw, repay and draw again up to a limit, paying interest only on what is outstanding. A term loan is advanced once and repaid on a fixed schedule. Lenders size a line against working assets or the working capital cycle, and a term loan against cash flow. Most established businesses need both.
- Line of credit
- Revolving; draw and repay as needed, renewed periodically
- Term loan
- Advanced once; repaid on a fixed amortization schedule
- Line funds
- Receivables, inventory, seasonal and timing gaps
- Term loan funds
- Equipment, acquisitions, buildings, refinancing
- The usual mistake
- Paying for long-lived assets out of the line
How each one works
A line of credit (a revolver) gives the business a limit it can borrow against at any time. Money drawn to pay suppliers comes back when customers pay, and the balance goes down; the next month it goes up again. Interest accrues only on the drawn balance, though lenders commonly charge a fee on the unused portion for keeping the commitment open. Lines are usually committed for a year or a few years and then renewed, re-sized or ended at the lender's decision.
There are two broad kinds. A cash-flow line is sized on the business's earnings and balance sheet, with covenants to protect the lender. An asset-based line has availability that moves with a borrowing base: a set share of eligible receivables and inventory. Asset-based lenders typically advance 80% to 90% of eligible receivables. See asset-based vs cash-flow lines.
A term loan is advanced in one amount, or in a few draws over a short period for a delayed-draw loan, and repaid in regular installments of principal and interest over a set term. Some term loans amortize fully; others leave a balloon at maturity that must be refinanced. What is repaid cannot be borrowed again.
Side by side
| Line of credit | Term loan | |
|---|---|---|
| Repayment | Revolves; balance rises and falls with the cycle | Fixed schedule of principal and interest |
| Re-borrowing | Yes, up to the limit or borrowing base | No; repaid principal is gone |
| Interest | On the drawn balance, plus usually an unused-line fee | On the full outstanding balance |
| Life | Committed for a year or a few years, then renewed | Set term, sometimes with a balloon |
| Sized on | Receivables and inventory, or the working capital cycle | Cash flow available to service debt, and the asset's life |
| Key lender tests | Borrowing base, and often a clean-up period or coverage covenant | Debt service coverage and leverage |
| Reporting | Monthly or more often: borrowing base certificate, AR and AP agings | Periodic financial statements and covenant certificates |
| Right use | Short-cycle needs that convert back to cash | Long-lived assets and one-time uses |
Match the loan to what it funds
The rule every credit officer applies is simple: the loan should repay on the same rhythm as the thing it funds. Inventory bought for the season is sold within the season, so the line that bought it is repaid from the sales. A truck earns its cost back over years, so the loan that bought it should run over years, and should not outlast the truck.
- Receivables and inventory growth. A line, ideally asset-based if the business is growing fast, because availability rises with the assets.
- Seasonal build and timing gaps. A line. Borrowing a term loan for a seasonal need means paying interest all year on money that sits idle half of it.
- Equipment and vehicles. A term loan or equipment loan with a term matched to useful life. Transparent's book has 244 lenders that write equipment.
- Buying a business. A term loan, sometimes with a line alongside for the target's working capital. See SBA 7(a) vs a conventional acquisition loan.
- Replacing expensive short-term debt. A term loan. Merchant cash advances in particular should be refinanced into term debt, not rolled into a line.
- A permanent step up in working capital. Often a mix: part of the need is permanent and suits term debt, and the swing on top of it suits a line.
How lenders size each one
A line is sized to the working capital it funds. For an asset-based line, the borrowing base sets availability each day: eligible receivables at an advance rate, plus eligible inventory at a lower one. Receivables more than 90 days past invoice typically drop out, and any single customer is commonly capped at 20% to 25% of eligible receivables. For a cash-flow line, the lender looks at the business's peak need across the year, measured from the working capital cycle. A business with receivables of 600, inventory of 300 and payables of 250 at its seasonal peak has a funding gap of about 650; a line near that size, less whatever the business can fund from its own cash, fits the need. See how lenders size a working capital line.
A term loan is sized to cash flow. Conventional bank lenders commonly look for debt service coverage of at least 1.25x: cash flow available for debt service divided by the year's principal and interest. SBA requires at least 1.15x, and from 1 October 2026 a change of ownership must show 1.25x on historical results. Senior cash-flow lenders to lower-middle-market companies also cap total debt, commonly at 2x to 3.5x EBITDA. Most lenders count a drawn line in that total, so a business at its leverage limit on a term loan has less room for a line, and the reverse. See how much debt can my business carry.
A line is sized to what the business owns and is owed. A term loan is sized to what the business earns. Asking one to do the other's job is where both go wrong.
The mistakes lenders see most
Funding long-lived assets on the line. An owner buys equipment, pays for a build-out or funds an acquisition deposit from the revolver because the money is there. The line never comes back down. At renewal the lender sees a balance that has not moved in a year, which tells it the line is really term debt with no repayment schedule. Many cash-flow lines carry a clean-up requirement, a period each year when the balance must be at or near zero, precisely to catch this. The fix is to term out the stuck balance into a proper term loan, ideally before the lender asks.
Relying on a line that can shrink. An asset-based line's availability falls when sales fall, because receivables fall. The line is least available when a business under pressure most wants it. A cash-flow line can be reduced or not renewed if earnings slip. Neither should be the only source of liquidity for a fixed commitment.
Borrowing a term loan for a timing problem. Some owners take a lump sum to cover a seasonal gap, then carry the payments through the months when they had cash to spare. The interest is wasted, and the payments reduce the cushion for the next season.
Ignoring the covenants. Both facilities carry them. A line of credit may test coverage, leverage or minimum availability; a term loan usually tests coverage. See the covenants on a line of credit and, if one has already been missed, what to do after a covenant breach.
Most businesses need both
A typical established business carries a term loan for its long-term needs and a revolver for its working capital. They can come from one lender under one credit agreement, or from two: an asset-based lender with first claim on receivables and inventory, and a term lender with first claim on equipment and other assets, tied together by an intercreditor agreement. The second arrangement often produces more total capital, because each lender lends against what it values most.
The documents differ accordingly. A line or ABL lender wants an AR aging by customer with days outstanding, an AP aging, a balance sheet, a P&L and year-to-date P&L, and the debt schedule with existing liens; an inventory report if inventory is in the borrowing base; and often bank statements and tax returns. A conventional term lender wants the P&L, year-to-date P&L, balance sheet and debt schedule, and often an AP aging. Transparent's book holds 235 lenders writing asset-based loans and lines and 1,148 writing term and private credit, so a business that needs both can see both sides of the market at once.
Common questions
- Is a line of credit cheaper than a term loan?
- Per dollar drawn, it can be, and you pay interest only on what you use. But lines usually carry an unused-line fee, more reporting and the risk of not being renewed. The cheaper loan is the one that matches the need: a term loan used for a seasonal gap wastes interest, and a line used for equipment creates a renewal problem.
- Can I use a line of credit to buy equipment?
- Briefly, as a bridge until a term or equipment loan closes. As a permanent arrangement, no. The balance will not come down, the lender will notice at renewal, and you will have financed a multi-year asset with a facility that can be pulled or reduced within a year.
- What is a clean-up period?
- A requirement, common on cash-flow lines, that the balance be at or near zero for a stretch of time each year. It proves the line is funding a cycle rather than something permanent. Asset-based lines usually do not have one, because the borrowing base already ties the balance to working assets.
- What does it mean to term out a line?
- Converting a stuck revolver balance into a term loan with a repayment schedule. It restores the line's availability for its real purpose and gives the lender a clear path to repayment. Lenders usually prefer the borrower to raise it before renewal.
- Does a drawn line count against how much term debt I can borrow?
- Usually, yes. Most lenders measure leverage on total debt, including the drawn revolver, so room on one reduces room on the other. Asset-based lenders focus more on the collateral, but a term lender behind them will still count the line.