If you’re starting a business and looking for quick and easy financing, one source is as close as your wallet. Personal and business credit cards are an attractive way to pay for some of the…
If you’re starting a business and looking for quick and easy financing, one source is as close as your wallet. Personal and business credit cards are an attractive way to pay for some of the bills you’ll face as a business owner, especially in the early stages when cash flow can’t always match expenses.
The easy access to money cuts both ways, however. It can help your business get started and get you out of unexpected financial jams, but it can also add a mountain of unsecured, revolving debt to your bottom line, which can be difficult to pay off and could prevent you from getting additional financing. Here’s a look at the pros and cons of using a credit card to fund your business.
The Pros of Business Credit Cards
It’s easier to get financing. You might think that a bank or credit union would be the natural place to get financing for a new business. In fact, nearly one in three U.S. adults polled in the National Foundation for Credit Counseling’s 2018 Consumer Financial Literacy Survey said they would check with a community or national bank, credit union or online lender for a loan if they were starting a business. Only 7 percent said they would use a credit card.
However, getting a new business loan from a typical lender is not easy, especially if you’re still developing your product and don’t have a sales history. Requirements vary, but according to Hal Shelton, certified mentor with the nonprofit business mentoring group Score, author of the book “The Secrets to Writing a Successful Business Plan” and an angel investor, banks usually want applicants to:
— Have a strong credit score
— Make a down payment, also known as an equity injection
— Pledge assets as collateral
— Have some experience in the industry
“If you want to open up a doughnut shop and never sold retail in your life, you’re unlikely to get a bank loan,” Shelton says.
Business financing usually comes from a mix of sources, including personal funds. In fact, the same NFCC survey indicated one in four respondents would tap personal income sources to start a business. But credit cards are worth considering as an alternative to traditional credit sources, as you don’t need collateral or any of the other requirements a bank would typically want, except for a strong personal credit score.
Gerri Detweiler, education director for Nav, which helps business owners manage credit, says, “A business credit card is one of the fastest and easiest forms of funding business owners can get, especially for businesses that are younger and don’t have strong revenues.”
They allow you to separate personal and business. One of the important distinctions to make when you’re considering using a credit card to fund your business is whether to use a personal card, a business card or both. Personal cards are the easiest, as you already have them. But you could end up using credit that might be needed for other expenses associated with your family, home or car.
“One of the advantages of a business credit card is that you can often keep that activity off your personal credit card and truly separate business and personal credit,” Detweiler says.
Applying for a business credit card is similar to a personal one. It will hinge on your credit score and income.
They offer benefits and rewards. As you consider which business credit cards to get, pay attention to the rewards and bonuses they offer.
If your business finances are managed well, you could use your cards to pay for business expenses and earn rewards while doing so, says Michael Bovee, founder and president of Consumer Recovery Network, a debt settlement company. “That’s probably the No. 1 benefit.”
Also, be on the lookout for low introductory rates, balance transfer opportunities and introductory bonuses that make it easier to get through a rough patch in your business or get your company off the ground. The key is to promptly pay off the debt you might accrue or else that introductory APR could grow into a regular interest rate that’s much higher than one on a traditional bank loan for businesses.
Cards help you manage cash flow. If you make most of your purchases at the beginning of a monthly credit cycle, you can float those expenses for 30 days or more until the bill comes due. For example, a consultant who gets reimbursed for expenses as they occur could put the expenses on a credit card, bill the client, get paid by the client and pay off the card to avoid paying any interest, Shelton says. Or, a business could purchase furniture and new equipment and take advantage of the same grace period.
“If you’re disciplined and have cash flow to do it, it’s an advantage,” Shelton says.
You can keep track of expenses. When you’re starting a business, you might not have anyone dedicated to accounts receivable. Very often, you’re on the go and don’t have time to manage every purchase. Detweiler says a monthly statement and a weekly check online of your purchases can help you stay on track. You can also try to connect the purchases to your accounting software and even set alerts if your balance is over a certain amount.
The Cons of Business Credit Cards
You might be personally liable. Even though your business card is in the name of your business and technically not the same account as your personal card, you usually need to personally guarantee the business card debts. This can get even more complicated if you start a business with a partner and both of you are responsible for the debt, or if you give an employee access to the card and he or she goes on a spending spree just before leaving the company.
“That’s where I’ve heard a lot of horror stories,” Detweiler says.
For example, Detweiler dealt with the owner of a trucking company whose employee spent $2,000 on a company credit card and never showed up for work again. The owner tried to say it was fraudulent use, but the employee was an authorized user in the cardholder agreement.
“You’re responsible for every purchase they make, even if there are ones you don’t specifically approve of,” Detweiler says.
Also, one business partner might leave the company and not repay old credit card debts. Worse yet, that person might still have access to the card even after leaving the business, she says.
The end result is that you could put your own credit history and score at risk. It could endanger your ability to pay for your mortgage, car loans and other personal debts, as well as limit your ability to obtain traditional business loans in the years to come.
Confidence vs. reality. Entrepreneurs are eternal optimists, Bovee says, which can be dangerous when mixed with easy access to credit. In the last few years, he’s seen an increase in small business owners who are burdened with too much debt because they became overextended on business credit cards. The reality is that about half of businesses will fail within five years, according to the federal Bureau of Labor Statistics.
“You’re up against it to begin with,” Shelton says. Every startup believes it will be one of the successful ones to last more than five years, but many won’t, he says.
That’s why taking on excess debt during the early years of a business — when expenses are often at their highest and revenue is often low or nonexistent — can be dangerous.
Business owners need to realize that if they have a bad year and are projected to have the same result the next year, it might not be a good idea to rely heavily on credit cards to stay afloat, Bovee says. When you’re going into debt to cover normal expenses that the business should be able to cover, “that’s a wake-up call,” he says.
It’s easy to get maxed out. You might be able to get one or more business cards with credit limits in the $10,000 to $20,000 range, which can help with some startup or everyday expenses, but that only goes so far.
“If you’re looking for $200,000 to start your business, credit cards aren’t going to work. If you’re looking for $30,000, credit cards could work,” Shelton says.
Also, you could be using short-term financing for what might be a long-term financial need. Ideally, you would want to match your long-term costs — such as equipment and infrastructure — with longer-term financing, such as a loan, Shelton says.
Debt can accumulate quickly. If you’re working with a lender, you will be questioned about why you’re making certain purchases. Credit cards typically don’t ask about purchases.
It’s a source of funding that can help you get your business off the ground without a lot of scrutiny, Detweiler says. “That could be good or bad.” If you’re not disciplined, you might use your credit card for purchases that don’t directly affect the bottom line, such as furniture, while struggling to meet the payroll and end up with balances that you can’t pay off, she says.
The debt load becomes even tougher when it is exacerbated by high interest rates that can reach 20 percent or more once your introductory rates expire.
Alternatives to Business Credit Cards
It’s rare to have just one source of funding for a business, Shelton says. In addition to credit cards and traditional loans, here are a few other options:
— Tapping 401(k) and IRA accounts
— Borrowing from friends and family
— Starting a crowdfunding campaign
Shelton suggests breaking up funding into sections. Instead of trying to get all the money you need right away, figure out when you’ll need funds for particular goals as you go. If you show success in the market, it might be easier to go back and get more funding.
Before you obtain one or more business credit cards, it’s a good idea to meet with an advisor — such as a Score mentor or an official at a Small Business Administration office — to help you determine the next steps.
“Talk to someone who can give you that hard feedback whether what you’re planning to do with that money sounds like it makes sense or if you’re taking an unnecessary risk,” Shelton says. Create or update your business plan with the advisor, who will help you determine whether a credit card is the way to go and how much credit you might need.
Detweiler says even though one of the attractive aspects of a business credit card is that you don’t have to answer to a banker when you make a purchase, it’s still a good idea to be as rigid with yourself as a bank would. “Don’t spend it mindlessly — invest it wisely,” she says.