Small Business

The Credit Card Debate


Yes, plenty of entrepreneurs use plastic to get their businesses started, but most see it as a temporary solution, not a long-term strategy

People thinking about starting up their own companies are nearly always on the receiving end of some stern advice: Don't use credit cards to fund your business.

But the truth is that most entrepreneurs do rely on plastic in the early—and sometimes later—stages of forming their business. A March, 2007, survey done by the National Association of the Self-Employed (NASE) showed credit cards were second in popularity only to savings as the preferred method of startup funding and ongoing funding for micro-business owners—those with 10 or fewer employees.

When asked what they used for funding, 58% of the 469 survey respondents said "savings," and 10% said "credit cards" for startup; 36% said "savings," and 21% said "credit cards" for ongoing operations funding. The other choices, including money from friends and family, and bank or home equity loans, came in lower on the list of possible responses to both questions.

Of course, there's a valid reason would-be entrepreneurs are warned against putting their startup funding on credit cards. "The worst thing in the world is to have your business fail and be stuck personally with $50,000 in debt at 21% interest," says Joe Knight, a co-author of the book Financial Intelligence (Harvard Business School Press, 2005).

Credit Can Be a Good Cushion

The good news is that with some restraint and wisdom, credit cards can function as part of a sensible startup funding package. "When entrepreneurs take those first trembling steps, most have to take them alone. Credit can help them do that. And it can help them bridge the gap when they know that orders or sales are coming in, or a private investor is going to come through," says George Whitehead, business development director for the National Endowment for Science, Technology, and the Arts, a public-private partnership that invests in early-stage companies in Britain. "All kinds of unexpected things happen to small businesses. Credit can act as a cushion."

But it's a cushion that should be used sparingly and with caution, says Gene Fairbrother, president of Dallas's MBA Consulting and lead small business consultant for the NASE. "It's real easy to pull out that plastic. If you're going to do it, you need to know what maximum level of debt you feel comfortable with and stop there. It's like going to Las Vegas: You need to decide how much you can afford to lose before you start gambling. Otherwise, things can easily get away from you."

Don't make the mistake of thinking you can rack up debt on a business credit card and then walk away from it if your business venture doesn't work out, Fairbrother says. "Even though you get a credit card with your business name on it, make no mistake that you will personally guarantee that debt. It's like getting a bank loan: Your personal assets are going to be on the line if you're a startup entrepreneur." U.S. bankruptcy reform legislation passed in 2005 also makes it more difficult to retire debt from a failed venture, he notes.

What the Experts Are Saying

So how can an entrepreneur use credit cards successfully to get a company off the ground? Here are some expert suggestions:

"A year prior to your starting a company, gather every credit card offer that comes your way, so you have a lot of credit pre-approved and accessible to tap into," says Janice Machala, founder of business and financial services firm Paladin Partners, of Kirkland, Wash. "It's much easier to get a credit card with high limits when you have a paying corporate job and look more stable."

Research card agreements and get the best deal possible. "We get calls all the time from people whose interest rate went from 9% to 18% because they were two days late on a payment," Fairbrother says. "Some companies even go into your credit report and if your score is lower than a certain amount they can take your rate from 12% to 32%." If you read the fine print and compare agreements, you can find the lowest rates and most favorable terms. "Google 'credit-card rates' and you'll find a gazillion Web sites that match up credit cards based on their annual fees, interest rates, and other parameters, he says.

Check your credit report annually and request your FICO score at least twice a year. "This is the most important determining factor in your ability to get loans, credit cards, and financing," Fairbrother says. Look for ways to improve your score, and you'll be able to get better credit-card deals.

If you plan to "float the note"—juggle your debt using credit cards with short introductory periods of no interest or low interest—you'll need to set up a spreadsheet and track your expenses meticulously. "If you use good cash planning, and you're careful to pay cards off at the right times, this can work. One guy I know juggled $50,000 for nine months nearly interest-free, and by then his company was on its feet," Knight says. In order to be successful, you have to know exactly when the initial interest rates go up, and how large a cash advance you can get on what card. Some card companies charge fees or points for cash advances, which means you may need to start putting expenses on a new card before the current card you're using raises its rate, Knight says, rather than plan to pay off one card with a big chunk of money from a new card.

Don't leave your day job and expect to live on credit cards until your business breaks even. "Some people use credit because they've quit their jobs to live the dream. But a lot of them have jumped too quickly without fully understanding what they're stepping into," Whitehead says. "Look into whether you can work a half-time job while you're building up your business, gaining market understanding, and writing a business plan (BusinessWeek.com, 1/7/08). That way, you're not stopping that lifeblood of income coming in too quickly."

If you are starting a company with a partner or two, make sure each of you takes on an equal share of credit-card debt. "Sit down and strategize about who's going to guarantee each card. If you don't share responsibilities, time, burden, and personal guarantees with your partners, you're asking for a big dispute eventually," Knight says.

Manage your risk and go into your venture with eyes wide open. The sad truth is that early-stage businesses are quite likely to fail. "If you and your family are really going to be hurt if you lose that money, then you shouldn't invest it," Whitehead says. "This rule applies to angel investors as well as entrepreneurs. The horrible dilemma for an entrepreneur is deciding when to take a risk and when to quit." Talk to your family and establish some parameters before you start racking up risky, high-interest debt.

Be careful not to make so many credit-card applications that you'll be hurt later. "If you are going to go for a bank loan at some point in the future, you have to keep your FICO score reasonably high. If you make too many credit-card applications, that can lower your score," Fairbrother says.

Use Knight's "double-half rule" in your financial planning: Getting to return-on-investment in your business will take twice as long as you think, and you'll bring in half as much revenue as you've projected.

Think of credit cards as a temporary solution, not a long-term strategy. "Consider the other sources of funding available, and consider them far earlier than you think you need to," Whitehead advises. "The reason a lot of people rely too heavily on credit cards and find themselves in this desperate state of overstretching is because they underestimate the lead time they'll need to close a sale or an investment deal or get a loan application completed and cash in the bank." Start looking at more sophisticated sources of funding, such as bank loans or private investors (BusinessWeek.com, 3/12/07), from day one of your business. "It will take longer than you think to make that next step—probably six months or more," he says.


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