Credit Card Debt Hurts Startups

Posted by: John Tozzi on August 6, 2009

Startups that lean too much on credit cards are more likely to fail, according to a new report (PDF) from the Kauffman Foundation. The study found that every $1,000 of credit card debt increases the probability that a new firm will close by 2.2%.

Credit cards have increasingly replaced traditional loans, and this study suggests that taking on credit card debt is one factor that contributes to business failure. Researcher Robert Scott examined 5,000 firms started in 2004 and tracked their progress through 2006 using data from the Kauffman Firm Survey. About 58% of them used credit cards to fund their business in the first year, and nearly one-third of those carried a revolving balance. The average debt for those companies with outstanding balances at 2004 was $11,000. (When you also include those with no credit card debt, the average was $3,500.)

Most of the firms in the sample (59%) had no employees when they were founded, and only 18% had three or more, so this applies mainly to microbusinesses. That also likely means that many of the owners had their personal credit intertwined with their business finances. Simply using credit cards did not correlate to success or failure, but carrying a balance on them did. Scott found that “credit card debt increases and then eventually stabilizes to a manageable level during many firms’ first few years of operation, while firms with high credit card debt close and successful firms start paying off their debt.”

The report notes that “with the recent contraction of credit markets, many new businesses will face difficulties in accessing traditional forms of credit, which likely will create greater demand for credit cards.” Small business’ shift to credit card financing was well underway for years before the credit crunch, as card issuers aggressively pushed into what had been an relatively untapped market over the past decade. The top small business lenders are credit card issuers.

Let’s think about the implications for a second. The most readily available source of credit for new small businesses is one that, the evidence suggests, damages the business’s chance of survival. Does that strike anyone else as an enormous failure of our financial system?

Recent credit card reforms, while a step in the right direction, fail to give small business owners the same protections that consumers will have. But it seems like there’s a market opportunity for a new methods of small business financing that don’t actually damage the borrowers’ chance of success. We began exploring some of them a few months ago in this post — ideas like peer-to-peer lending through Kiva or loans and investments through community development financial institutions. It’s a conversation worth continuing. What other alternatives to credit card borrowing are emerging?

Reader Comments

Joe Raby

August 10, 2009 9:53 AM

I'm the owner and co-founder of a shared office community, www.sunshineny.com, that focuses on 1-5 person companies to rent shared office space from us. In my 8 years of running this business I've seen literally thousands of small businesses and startups, and almost all of them rely on using credit cards to finance their start up costs. But the ones that survive tend to use credit card debt intelligently (like using low interest rate balance transfers and making sure one card for purchases is paid off in full every month). Every one uses cc debt since it is the easiest and cheapest way to finance a start up - but use it with common sense and planning, not to put out fires.

credit card debt

August 11, 2009 7:15 AM

Thanks for sharing such great post, according to me elimination of credit card debt isn’t an easy thing to do, especially in today’s life when money is tight for everyone. So according to me using of cash than credit card is better option. For more details refer http://www.prime-targeting.com/7-tips-to-eliminate-credit-card-debt/

Max K

August 11, 2009 12:45 PM

Other alternatives to financing, which are especially appropriate for high margin businesses, are merchant credit cash advances and account receivable factoring. With merchant credit cash advances, businesses that accept credit cards can quickly obtain advances against future sales with minimal documentation. These advances can be used fund bulk inventory purchases or any other purpose. Similarly, businesses with accounts receivable can sell their receivables to obtain cash today, rather than having to wait 60-90 days to receive the funds. For additional information see www.bluestonefunding.com.

John Tozzi (BusinessWeek reporter)

September 1, 2009 12:13 PM

For a contrarian take on this, check out Scott Shane's post over at NYTimes.com: http://bit.ly/BKYAq

Annie Masias

October 1, 2009 8:12 AM

Excessive credit card debt can be one of the most stressful problems any family can go through. It's no fun having to surrender a substantial portion of your paycheck to the credit card companies. Likewise, late payments and debt collectors can keep you up at night with worry about how in the world you're going to solve your debt problem.

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What's it like to run your own company today? Entrepreneurs face multiple hurdles new and old, from raising capital and managing employees to keeping up with technology and competing in a global marketplace. In this blog, the Small Business channel's John Tozzi and Nick Leiber discuss the news, trends, and ideas that matter to small business owners. Follow them on Twitter @newentrepreneur.

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