Almost everyone has heard of entrepreneurs that were unable to raise capital for their business and used credit cards to finance their start-up. And, this practice has become even more prevalent over the past year. Even existing small businesses use credit cards to finance certain expenses. While credit cards can be a great financial “stop-gap” tool, is it really a good idea to use them to fund a small business?
Pros
A credit card can be an effective way to finance expenses when there are no other options available. Provided you already have a credit card with a decent line of credit, this can be a great vehicle for short term financing because it is quick and easy. Minimum payments are generally small, maybe 1% of the balance. In addition, some cards allow you to earn rewards by making purchases (as opposed to cash withdrawals) that can save you money on other expenses.
Cons
Interest rates are typically higher, in some cases substantially higher, than other means of financing. If you use your credit card to secure cash (as opposed to a purchase) the fees and interest rates are usually even higher (some as high as 25%). Almost always, even with business credit cards, the small business owner or company officer is liable for the debt. Although incorporating your business may offer some personal protection to you as the business owner for most liability, you will notice that even with business credit cards, the statement you must sign requesting the credit card is a personal guarantee.
Start-Ups
If an entrepreneur has a great idea and has built a thorough business plan (see “Is a Written Business Plan Really Necessary?”) so, rather than just a “gut feel”, they know that potential rewards are high and the risk of failure is low, and they are unable to secure other means of funding, it may make sense to fund the venture with credit cards. However, there are a couple of things to keep in mind. First, if the business fails, chances are high that you will be personally liable to repay the debt, short of personal bankruptcy. Secondly, keep in mind that at an interest rate of, shall we say, 18% and, if you make just minimum payments of shall we say, 1% of the balance (plus interest), it will take you 32 years to pay off the loan!
If, after doing thorough research you feel your odds of success are high and will come quickly so you can pay down the debt much faster than just the minimum payments, then this might be an acceptable option. However, think long and hard before taking that step and be prepared for the consequences if the business fails.
Existing Businesses
It is a common practice for existing businesses to use company credit cards because it makes life easier for purchases. They are generally paid off when the statement arrives but sometimes are used for short term, shall we say, 90 day financing. In these cases, especially when you can use the rewards (e.g. airline mileage or points), this makes very good sense. However, company credit cards are generally not a good source for funding an operation because the interest rate is usually much higher than personal credit cards; interest rates and fees for cash withdrawals are even higher; and the small business owner is still usually personally responsible for the debt. So, for a small business owner and/or entrepreneur, if you have no other choice but to finance a debt with credit cards and you feel comfortable with the personal liability, why not use a personal credit card instead of a company credit card if the interest rate is lower?
Dealing With Credit Card Debt
So what should a small business owner do who has already amassed credit card debt? Well, that depends primarily on your credit rating or the rating of your company. If you can secure a lower interest rate on a loan or line of credit to pay off the credit card debt without personally guaranteeing it, you are in a far better position. If that is not possible, according to SBA Loan Specialist, Coralie Myers, an entrepreneur with good credit can refinance credit card debt with an SBA loan. The requirements are that the credit cards must have been used solely for the business, and the business owner must have the receipts to back it up. With SBA loans available with interest rates at under 10%, this could be a far better option if the business is viable. You will no doubt need a business plan to secure an SBA guaranteed loan. If neither the small business owner nor the business has good credit, then the only remaining option may be to simply pay it down as quickly as possible.
Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009
You may have heard that President Obama has signed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009 to prevent banks from charging higher interest rates and to offer some additional protections. How will this affect you as a small business owner? Before you start cheering, there are a couple of things you should know. First of all, it does not go into affect for another nine months. Until then, the banks can charge whatever they desire within the current legal structure. Second, the Act only protects personal credit cards and company credit cards for companies with more than 50 employees. That’s right, the protection for small businesses with less than 50 employees was removed prior to its signing. It seems to me that as banks try to recoup their recent losses that the temptation will be great to hike the rates and fees on company credit cards for small businesses.
This is another reason to use “personal” credit cards if the small business owner must rely on credit cards for some type of funding. The rub? More than 90% of American businesses have fewer than 50 employees and these small businesses are the very same companies that create job growth. It sure makes you wonder what our lawmakers were thinking!
If you would like to contact me, you can do so by emailing me at mike.clough@bestbizpractices.org or visiting my LinkedIn page.
Posted by: Mike Clough
