Letter Of Credit

A loan...option. Or rather, an option of getting a loan. A letter of credit is just a promise from a lender, usually a bank, stating that if the borrower in fact needs credit, she can get it.

Why do LOCs matter? Well, at times, companies need the certainty of being able to get credit down the line. For example, whatever.com might realize that they need to buy whoever.com if they don't have a great Christmas season. Whoever.com has indicated in writing that they're willing to be bought for $82 million. So whatever.com will need to come up with that cash at that time. They have $50 million in the bank and would likely need credit for another 40 or 50 or so to cleanly get the deal done.

Hence, a LOC simply gives certainty to a borrower for some period in the future when they may or may not need the dough. Think of it as liquidity life insurance.

See: Line Of Credit - LOC.